Real Estate Finance

Mortgage Products in Hong Kong

Kwok-Sang (Maurice) Tse

Faculty of Business and Economics
The University of Hong Kong
ktse@hku.hk

k s tse 1
 Effect of Mortgage Interest Rates on
Property Market
◼ Tuesday, January 31, 2006, South China Morning Post
High rates sink sales in primary market
“Only 100 units expected to have been sold this month as
homebuyers stay put.”

◼ Tuesday, February 21, 2006; South China Morning Post

Mortgage war triggers rally in property stocks
“Property stocks shone as investors expect the lower mortgage
rates offered by banks to send property prices up. The increase
in sales of new flats was also read as a good indication of a
bullish property market.”

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 Reported Issues on Negative Equity
◼ Friday, January 13, 2006, South China Morning Post
Negative equity: Who bears most pain
◼ 70pc of affected households bought at 1997 peak, says HKMA

◼ “The typical homeowner struggling with negative equity is a middle-income

household earning between $20,000 and $50,000 a month that bought a
property below 600 square feet in the New Territories at the height of the
1997 boom.”

◼ Tuesday, February 7, 2006; South China Morning Post

Negative equity jangles nerves
◼ Yam blames rising interest rates as 21pc more homeowners fall outside

the comfort zone in second quarterly increase

◼ “Almost 2,000 more households slipped into negative equity in the final
three months of last year, a 21 per cent surge over the previous quarter to
11,000 mortgages with an aggregate value of $19 billion.”

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 Contents
◼ Mortgage Design
◼ Term Loan (Straight Loan)

◼ Fully Amortized Mortgages

◼ Partially Amortized Mortgages

◼ Fixed Interest Rate Mortgages

◼ Growing-Equity Mortgages (GEM)

◼ Rapid-Payment Mortgages (RPM)

◼ Biweekly Mortgages (BWM)

◼ Graduated Payment Mortgage (GPM)

◼ Mortgage Products in Hong Kong

◼ ARMs, FRMs, Deposit-Linked Mortgages

◼ Special Mortgages:
◼ Shared-Appreciation Mortgages (SAM)

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 I. Mortgage Design
◼ Term Loan (Straight Loan)
Loan I I I I I …… Principal + I

0 1 2 3 4 5 n

◼ The straight or term mortgage loan provides for repayment of

the principal amount of the loan at maturity. No provision is
made to reduce the principal during the term of the loan.
◼ The borrower pays interest only at stated intervals, usually
monthly, quarterly, semiannually, or annually.
◼ At the end of the loan term, the principal amount of the loan
must be paid off along with the unpaid interest.
◼ The term of the loan usually varies from one to five years.
◼ RISK?
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 I. Mortgage Design
◼ Fully Amortized Mortgages
Loan PMT PMT PMT PMT PMT ………. PMT

0 1 2 3 4 5 n

PMTt =Interestt +Principalt

◼ Fully amortized mortgage provides for gradual repayment of the
total principal amount over the term of the loan.
◼ Periodic payments include both principal and interest.
◼ At maturity the outstanding loan balance will be reduced to zero.
◼ The term of fully amortized residential mortgages generally
varies from 10 to 20 or even 30 years.
◼ Problem?

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 I. Mortgage Design
◼ Partially Amortized Mortgages
Loan P P P P P ………. P + Balloon

0 1 2 3 4 5 n

Pt =Interestt +Principalt <PMT

◼ The periodic payments on the partially amortized mortgage are
less than that of a fully amortized mortgage of the same amount
with the same terms.

◼ Periodic payments include both principal and interest, so that at

maturity, only part of the principal is paid off. The balance of the
principal, the balloon, is due at maturity.
remaining balance
should be less than principle

◼ Who would borrow this kind of mortgages??

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 I. Mortgage Design
◼ Partially Amortized Mortgages
Loan P P P P P ………. P + Balloon

0 1 2 3 4 5 n

Pt =Interestt +Principalt <PMT

• Who would borrow this kind of mortgages??
• Newly formed businesses with large start-up costs and cash
flow problems are likely candidates for this kind of mortgages.
• The bank expects that the cash flow crisis experienced by the
new firm is short term, and that within a few years when the
loan has matured, the then more experienced firm will be in a
position either to pay off or refinance the balance.
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Example (Excel File: Financing Real Estate)
◼ Example: Consider a 10-year, 10% mortgage loan of
$1,000,000 requiring monthly payments.

◼ Determine the mortgage payments for

◼ Term loan
◼ Fully amortized mortgages
◼ Partially amortized mortgages with monthly payments
fixed at $9,000.

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 Example

◼ Consider a 10-year, 10% mortgage loan of $1,000,000

requiring monthly payments.
◼ Determine the mortgage payments for term loan.

◼ Monthly interest payments = $1,000,000*10%/12 = $8,333.33

◼ There are 120 monthly interest payments
◼ Principal Payment at the end of year 10 = $1,000,000

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 1 − (1 + 𝑟)−𝑛
Example 𝐿𝑜𝑎𝑛 = 𝑃𝑀𝑇 ×
𝑟
◼ Consider a 10-year, 10% mortgage loan of $1,000,000 requiring
monthly payments.
◼ Determine the mortgage payments for fully amortized mortgage.

◼ The present value of all future equal monthly payments must

be equal to the mortgage loan.
◼ There are 120 equal monthly payments each of which
includes interest payment and principal payment.
æ æ ö
- 120 ö
ç1- ç1+ 10% ÷ ÷
ç è 12 ø ÷
1,000,000 = PMT ç ÷Þ PMT =13,215.07
ç 10% ÷
ç 12 ÷
è ø Total interest payment = 13215.07 x 120 - 1000000

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 1 − (1 + 𝑟)−𝑛 𝐵𝑎𝑙𝑙𝑜𝑜𝑛
Example 𝐿𝑜𝑎𝑛 = 𝑃𝑀𝑇 × +
𝑟 (1 + 𝑟)𝑛
◼ Consider a 10-year, 10% mortgage loan of $1,000,000 requiring
monthly payments of $9,000.
◼ Determine the mortgage payments for partially amortized mortgage.

◼ The present value of all future monthly payments and the

balloon payment must be equal to the mortgage loan.
æ æ ö
- 120 ö
ç1- ç1+ 10% ÷ ÷
ç è 12 ø ÷ Balloon
1,000,000 = 9,000 ç ÷+ 120
Þ Balloon = 863,436.7
ç 10% ÷ (1+10% /12)
cheaper = less total interest payment ç 12 ÷
è ø
Total interest for Term Loan = 8333.33 x 10 years x 12 number of payments per year = 1000000
◼ Question: What happens if the monthly payment is set at say
$8,000 (less than the monthly interest $8,333 for term loan)?
Total interest for Fully amortized Loan = 13215.07 x 10 years x 12 number of payments per year - 1000000 = 585808.84
Total interest for Partially amortized with balloon = 9000 x 10 years x 12 number of payments
per year + 863436.68 last payment - 1000000 = 1028281.66k s tse 12
 Contents
◼ Mortgage Design
◼ Term Loan (Straight Loan)

◼ Fully Amortized Mortgages

◼ Partially Amortized Mortgages

◼ Fixed Interest Rate Mortgages

◼ Growing-Equity Mortgages (GEM)

◼ Rapid-Payment Mortgages (RPM)

◼ Biweekly Mortgages (BWM)

◼ Graduated Payment Mortgage (GPM)

◼ Mortgage Products in Hong Kong

◼ ARMs, FRMs, Deposit-Linked Mortgages

◼ Special Mortgages:
◼ Shared-Appreciation Mortgages (SAM)

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 II. Fixed Rate Mortgages (FRMs)

◼ A fixed rate mortgage (FRM) is any loan having an

interest rate that remains unchanged over the life of
the mortgage.
◼ The typical term of fixed rate mortgages varies from
10 to 30 years.
◼ The most popular fixed-rate mortgage is the fully
amortized loan.

◼ Advantages??
◼ Disadvantages??

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 Assets Liabilities +Equity
Important Issues Mortgages Deposits + Equity
◼ Mortgage lending is long-term, usually 10 years or even 30 years.
1. Mortgages are subject to high interest rate risk.
◼ Market interest rate increases ➔ MV of mortgages decreases

◼ Market interest rate decreases ➔ MV of mortgages increases

2. Banks need liquidity in order to make more new loans to more

borrowers
3. Banks are concerned about the quality of mortgages as gauged
by LOAN-TO-VALUE ratio
4. Borrowers want to save interest cost whenever possible.
measure asset risk to bank

◼ Want a product that will (1) reduce the loan-to-value

ratio quickly and (2) save interest cost to borrowers??
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 1. Growing-Equity Mortgages (GEM)
◼ GEM has provisions that may appeal to many
homeowners.
◼ “With the GEM mortgage, loans of 80, 90, or 95 percent
loan-to-value ratio are common, with fixed interest
rates and loan terms of 25 to 30 years.”
◼ Mortgage interest rate is fixed, but monthly payments
rise by a predetermined 3 to 4 per cent a year.
◼ Increase in the amount of the monthly payment is used
to reduce the mortgage balance, thereby accelerating
the payoff on the mortgage.
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 GEM contd
◼ Example. Consider a 20-year, fixed rate, $10,000
mortgage with an interest rate of 12%.
◼ With a GEM mortgage, the initial monthly payments
are determined using 12% and 20-year term.
◼ The monthly payments will increase by 3.75% per
year with the increase in payments applied to
principal.

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 Schedule of Payments and Amortization for GEM
GEM Loan = $10,000, Mortgage Interest Rate = 12%,
Annual increase of payments = 3.75%, Term = 20 years

Contd Year
Monthly
Payment
Annual
Interest
Annual % Principal Remaining
Principal repaid Balance
0 10,000
1 $110.11 1193.10 128.20 1.3% $9,871.80
2 $114.24 1174.02 196.83 3.3% $9,674.97
◼ Schedule of
3 $118.52 1146.14 276.12 6.0% $9,398.85
Payments and 4 $122.97 1108.08 367.51 9.7% $9,031.34
Amortization 5 $127.58 1058.33 472.60 14.4% $8,558.74
6 $132.36 995.12 593.21 20.3% $7,965.52
◼ How would 7 $137.33 916.50 731.40 27.7% $7,234.12
the 8 $142.47 820.23 889.47 36.6% $6,344.65
payments 9 $147.82 703.78 1070.04 47.3% $5,274.62
10 $153.36 564.28 1276.04 60.0% $3,998.57
compare 11 $159.11 398.52 1510.82 75.1% $2,487.76
with those 12 $165.08 202.84 1778.10 92.9% $709.66
under 12+1 month $171.27 7.10 164.17 94.5% $545.49
convention 12+2 $171.27 5.45 165.81 96.2% $379.67
al fixed rate 12+3 $171.27 3.80 167.47 97.9% $212.20
mortgage?? 12+4 $171.27 2.12 169.15 99.6% $43.05
12+5 $43.48 0.43 43.05 100.0% $0.00

TOTAL 10299.86
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 GEM Contd.
◼ If the mortgage is a conventional 20-year, fixed rate
mortgage, then the monthly payment will be $110.11
for 240 months.
◼ Total interest will be $16,426.07
◼ (= 110.11 * 240 - 10,000).

◼ Total interest paid in GEM = $10,299.86

◼ GEM will save $6,126.21 for the borrower in total
interest.
◼ Advantages??
◼ Disadvantages??
k s tse 19
 Advantages of GEM
◼ Homeowner will own the property free and clear in shorter time
period.
◼ Total interest paid is substantially less.
◼ Homeowner may obtain a lower rate of interest than on the
traditional 20-year fixed rate loan.
◼ This instrument also finds broad appeal among institutional
investors and pension funds in the U.S. because of the relatively
secure nature of the investment and the shorter time period of
time over which their capital is tied up.
◼ Main disadvantage of the GEM mortgage is that the monthly
payment increases may outstrip the borrower’s salary increases,
thereby making the possibility of default more likely.
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 2. Rapid-Payment Mortgages (RPM)

◼ The RPM is another means of obtaining the benefits of

the GEM mortgage without incurring the disadvantage
of increasing monthly payments.

◼ RPM is just the standard mortgage with shorter

maturity/tenor, say 10 years rather than 20 years.

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 RPM Contd.
◼ Example.
◼ Consider a $1,000,000, 12.5% fixed-rate mortgage.

◼ Monthly principal and interest payment on 20 year term is $11,361.

◼ Monthly principal and interest payment on 10 year term is $14,638

◼ Monthly difference = $3,277 per month.

◼ Total Interest Cost under 10-year term = $756,514

◼ Total Interest Cost under 20-year term = $ ???? (Excel Template)

−𝑛 ◼ r is the periodic
1 − (1 + 𝑟) interest rate
𝐿𝑜𝑎𝑛 = 𝑃𝑀𝑇 ×
𝑟 ◼ n is the total no.
of payments

k s tse 22
 3. Biweekly Mortgages
◼ Biweekly mortgage is another variation of the
conventional fixed rate mortgage.
◼ Banks in Hong Kong also offer biweekly option to
mortgage borrowers.
◼ Main difference between biweekly and the traditional,
say 20 year, fixed rate mortgage is that the borrower
makes a payment every 2 weeks instead of every
month.
◼ Biweekly payments reduce the principal balance faster,
resulting in a much shorter loan term.

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3. Biweekly Mortgages 1 − (1 + 𝑟)−𝑛
𝐿𝑜𝑎𝑛 = 𝑃𝑀𝑇 ×
𝑟
◼ With the traditional 20-year, fixed rate mortgage on a $10,000
loan at 12.5%, the monthly payments are $113.61, and the
loan is of course paid off in 20 years.
◼ During the term of the loan, the borrower will have paid
interest totaling $17,266.4 (=113.61 * 240 - 10000).
◼ With the biweekly loan, the biweekly payment is
$113.61/2 = $56.81
◼ Loan will be paid off in 15 years; and the total interest is
$12,181.27-- a savings of $5085.17.
◼ Details ?

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 Biweekly Mortgage Payments (Excel)
Biweekly Mortgage of $10,000 at 12.5% amortized over 20 years
◼ Payment
Biweekly Biweekly Biweekly Biweekly
Period Payment Interest Principal Balance
Scheme 0 10000
1 56.80703 48.07692 8.730104 9991.270
2 56.80703 48.03495 8.772076 9982.498
◼ Biweekly interest
3 56.80703 47.99278 8.814250 9973.684
= 12.5%/26 * 4 56.80703 47.95040 8.856626 9964.827
Previous Loan 5 56.80703 47.90782 8.899206 9955.928
6 56.80703 47.86504 8.941990 9946.986
Balance
7 56.80703 47.82205 8.984981 9938.001
st 8 56.80703 47.77885 9.028178 9928.973
◼ 391 Biweekly
9 56.80703 47.73545 9.071582 9919.901
period = 391/26 10 56.80703 47.69183 9.115196 9910.786
11 56.80703 47.64801 9.159019 9901.627
= Year 15.04 12 56.80703 47.60397 9.203053 9892.424
388 56.80703 0.944378 55.86265 140.567
389 56.80703 0.675807 56.13122 84.436
390 56.80703 0.405946 56.40108 28.035
391 28.17040 0.134787 28.03561 0
TOTAL $12,181.27
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 4. Graduated Payment Mortgage (GPM)
◼ GPM provides for reduced monthly payments during the early
years of the loan.
Payment Level
|
| GPM
| ____________________________________
|
| ________
|
| ________ CPM
|....................................................................
| ________
|
|_______
|
|_______|_______|_______|_______|_______|______.....________________|_
0 1 2 3 4 5...................... n years

◼ Payments rise by a predetermined amount every year for an agreed

upon amount of time, up to say 10 years.
◼ Payments then remained fixed for the balance of the mortgage term.
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 GPM
◼ Who would borrow GPM??
◼ GPM allows the homeowner to acquire a more
expensive home than he/she could otherwise afford
because of the initially lower monthly payments.
◼ The main disadvantages are negative amortization and
increasing monthly payments in the early years of the
loan.
◼ Negative Amortization ??

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 GPM
◼ Negative Amortization
◼ Whenever the monthly payment on a loan is
insufficient to cover all the interest charges, the
deferred (unpaid) interest charges are added to the
loan balance.
◼ In this instance, the loan balance actually increases
rather than decreases -- negative amortization.
◼ Negative amortization is not always bad.
◼ If the homeowner lives in an apartment where the
value of housing is growing at a faster rate than the
outstanding loan balance is increasing yearly, it would
pay for the borrower to buy the house now using a
GPM mortgage.
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 Example-Negative Amortization
◼ Consider a 10-year, 12%, $1 million mortgage. The monthly
payments for the first 4 years are fixed at $8,000.
◼ The monthly payment for CPM is:
æ1- (1+12% /12)- 120 ö
1000000 = pmt ç ÷Þ pmt = $14, 347.1
è 12% /12 ø
The monthly payments
PMT = ??? beginning from the first
month of year 5 is
CPM: $14347
$22,011.
$8000

4 yrs 10 yrs

é1- 1.01- 48 ù 1 é1- 1.01- 72 ù

GPM: 1000000 = 8000 ê ú+ 48
PMT ê ú
ë 0.01 û 1.01 ë 0.01 û

k s tse 29
 Example-Negative Amortization Contd
◼ Recall the 12%, 10-year mortgage of $1m with monthly payments equal to
$8,000 for the first 4 years and $22011 for the remaining term.

Month PMT Interest Principal Balance

0 -- -- -- 1000000
1 8000 10000 (2000) 1002000 Negative
2 8000 10020 (2020) 1004020 Amortization

:
48 8000 1125871
49 22011 1115119
:
120 22011 0
◼ Risk indicator (quality indicator) for mortgages is the LOAN/VALUE ratio!!
◼ LOAN/VALUE > 1 ➔ mortgage is risky (Negative Net Worth to Homeowners)
◼ LOAN/VALUE < 1 ➔ mortgage is safe (usually less than 70%).
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 Negative Net Worth
Number of Cases
Source: Hong Kong Monetary Authority
120000
105697
100000

80000

60000

40000
10948
20000
2568
0
Q203
Q303
Q403

Q204
Q304
Q404
Q105

Q305
Q405
Q106
Q206
Q306
Q406
Q107
Q207

Q407
Q108
Q208
Q308
Q103

Q104

Q205

Q307

Q408
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 Contents
◼ Mortgage Design
◼ Term Loan (Straight Loan)

◼ Fully Amortized Mortgages

◼ Partially Amortized Mortgages

◼ Fixed Interest Rate Mortgages

◼ Growing-Equity Mortgages (GEM)

◼ Rapid-Payment Mortgages (RPM)

◼ Biweekly Mortgages (BWM)

◼ Graduated Payment Mortgage (GPM)

◼ Mortgage Products in Hong Kong

◼ ARMs, FRMs, Deposit-Linked Mortgages

◼ Special Mortgages:
◼ Shared-Appreciation Mortgages (SAM)

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 III. Mortgage Products in Hong Kong

◼ Adjustable Rate Mortgages (ARMs)

◼ A conventional adjustable rate loan has the borrower
sharing the risk of a fluctuating interest rate economy
with the lender.
◼ In Hong Kong, the ARM allows the lender to make
interest rate adjustments by referring to the prime rate
or HIBOR rate which is closely affected by the Federal
Reserve policy in the United States (because of the
linked exchange rate system between HK$ and US$).

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ARMs in Hong Kong

◼ ARMs in Hong Kong allow the borrower two

alternatives for adjustment when mortgage interest
rate increases/decreases.

◼ The borrower can either opt for an

increase/decrease in monthly payments with the
same term or an extended/shortened term with the
monthly payments unchanged.

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 Example-Elastic ARMs
Adjustable Rate Mortgage: Monthly Mortgage Payments and Interest Rates
(Mortgage Balance = 1,000,000)
Mortgage
Interest 5 years 10 years 12 years 15 years 20 years
Rates
6.0% $19,332.80 $11,102.05 $9,758.50 $8,438.57 $7,164.31
6.5% $19,566.15 $11,354.80 $10,019.21 $8,711.07 $7,455.73
7.0% $19,801.20 $11,610.85 $10,283.81 $8,988.28 $7,752.99
7.5% $20,037.95 $11,870.18 $10,552.26 $9,270.12 $8,055.93
8.0% $20,276.39 $12,132.76 $10,824.53 $9,556.52 $8,364.40
8.5% $20,516.53 $12,398.57 $11,100.56 $9,847.40 $8,678.23
9.0% $20,758.36 $12,667.58 $11,380.31 $10,142.67 $8,997.26
9.5% $21,001.86 $12,939.76 $11,663.73 $10,442.25 $9,321.31
10.0% $21,247.04 $13,215.07 $11,950.78 $10,746.05 $9,650.22
10.5% $21,493.90 $13,493.50 $12,241.41 $11,053.99 $9,983.80
11.0% $21,742.42 $13,775.00 $12,535.55 $11,365.97 $10,321.88
11.5% $21,992.61 $14,059.54 $12,833.17 $11,681.90 $10,664.30
12.0% $22,244.45 $14,347.09 $13,134.19 $12,001.68 $11,010.86
12.5% $22,497.94 $14,637.62 $13,438.57 $12,325.22 $11,361.41
13.0% $22,753.07 $14,931.07 $13,746.25 $12,652.42 $11,715.76
k s tse 35
 Fixed-Rate Mortgage in Hong Kong
◼ July 20, 2016

Bank Fixed Fixed Mortgage Prepayment

Rate Mortgage Rate Penalty
Term Rate Afterward Period (Yrs)
• OCBC Wing Hang 1 1.75% H+1.6 3
• ICBC(Asia) 1 1.80% H+1.7 3
• Hang Seng 1 1.88% H+1.6 3
1 1.88%
• Bank of
1.5 2.18% H+1.6 3
Communications
2 2.48%

k s tse 36
 Discussion
◼ How would you compare the mortgage loan between HSBC and Bank of
China? Assume that the price of property is HK$2 million, 70% lending, with
mortgage term of 20 years. The risk of HSBC mortgage is that its prime rate
may increase to the same level as all other banks.
Comparison HSBC Bank of China
5% for the first half year, P–2%
Mortgage Rate P–2.75
to P – 2.5% thereafter
Actual Mortgage Rate 5% (Prime is 7.75%) 6% (Prime is 8%; Prime–2%)

Cash Rebate 0 0.3%

Monthly Payment
HK$9,239 (total HK$55,434) HK$9,239 (total HK$55,434)
first half-year
Monthly Payment HK$9,239 (Assume Prime
HK$10,030 (Prime remains 8%)
after first half-year doesn’t change.)
HK$817,451
Total Interest Payment HK$1,000,223
(HK$862,371 if P goes up to 8%)
HK$2,217,451
Total Mortgage Payment HK$2,400,223
(HK$2,262,371 if P goes up to 8)

k s tse 37
 Mortgages in Hong Kong
◼ Adjustable Rate Mortgage
◼ Terms: Loan Amount, Tenor, Interest Rate
◼ Mortgage Interest Rate in Hong Kong:
more stable
◼ Option 1: Prime minus (e.g. Prime – 2.5%) Option 1 > Option 2
more volatile
◼ Option 2: HIBOR plus (e.g. HIBOR + 1.6%)
◼ The borrower can also consider setting a sinking fund
alongside the mortgage to cushion against the increase in
mortgage payments due to interest rate hike—the sinking
fund makes your mortgage behave like a FIXED rate
mortgage.
◼ Mortgage Term:
◼ (30-Property Age);
◼ Min(2047-Year of Mortgage; 30-Property Age)
k s tse 38
 Deposit-Linked Mortgage
◼Mortgage plan with deposit interest rate linked to mortgage
rate in order to reduce interest cost.
Example 1: HSBC STANDARD HIBOR-DEPOSIT
HIBOR-DEPOSIT LINK HIBOR LINKED
Mortgage Amount $3,000,000 $3,000,000
Hibor Rate 0.23% 0.23%
Hibor Plus 1.60% 1.60%
Mortgage Rate 1.83% 1.83%
Deposit Rate 0.01% 1.83%
Mortgage Tenor (Years) 25 25
Deposit Amount $500,000 $500,000
The deposit-linked rate only applies to savings balance not more than 50% of the
mortgage balance. The interest rate for the excess balance will be set equal to the
standard savings rate.
◼ How much interest is saved?
◼ See Excel file: Financing Real Estate
k s tse 39
 Deposit-Linked Mortgage
◼ Mortgage plan with deposit interest rate linked to mortgage
rate in order to reduce interest cost.
Example 2: Citibank STANDARD PRIME-DEPOSIT
PRIME-DEPOSIT LINK PRIME LINKED
Mortgage Amount $3,000,000.00 $3,000,000.00
Prime Rate 5.25% 5.25%
Prime Minus 3.10% 3%
Mortgage Rate 2.15% 2.25%
Despoit Rate 0.01% 2.25%
Mortgage Tenor (Years) 20 20
Deposit Amount $500,000.00 $500,000.00
The deposit-linked rate only applies to savings balance not more than 50% of the
mortgage balance. The interest rate for the excess balance will be set equal to the
standard savings rate.
◼ How much interest is saved?
◼ See Excel file: Financing Real Estate
k s tse 40
 Contents
◼ Mortgage Design
◼ Term Loan (Straight Loan)

◼ Fully Amortized Mortgages

◼ Partially Amortized Mortgages

◼ Fixed Interest Rate Mortgages

◼ Growing-Equity Mortgages (GEM)

◼ Rapid-Payment Mortgages (RPM)

◼ Biweekly Mortgages (BWM)

◼ Graduated Payment Mortgage (GPM)

◼ Mortgage Products in Hong Kong

◼ ARMs, FRMs, Deposit-Linked Mortgages

◼ Special Mortgages:
◼ Shared-Appreciation Mortgages (SAM)

k s tse 41
 V. Shared-Appreciation Mortgages (SAM)
◼ Shared-appreciation (or equity participation) loan has been
mainly used by commercial lenders in the United States.

◼ Lender offers the borrower a fixed-rate mortgage at below the

market rates in exchange for a share of the profits either upon
resale or after a stipulated period of time, usually 5 to 10
years.

◼ Under the terms of the mortgage, the lender usually promises

to refinance the property with a long-term mortgage after the
pre-designated 5- to 10-year period, thereby enabling the
buyer to pay the lender’s share of the property appreciation
even if the property is not sold.

k s tse 42
 æ1- (1+ 9% /12)- 360 ö
6mill = PMT ç ÷Þ PMT = 48, 277.35
9% /12
Example-SAM è ø
æ1- (1+ 9% /12)- 240 ö
Balanceyr10 = 48277.35ç ÷= 5, 365, 784.6
è 9% /12 ø
◼ Suppose a developer has a real estate project valued at $7.5 mill and
borrows a 30-yr, $6 mill below market fixed rate SAM mortgage at 9%
interest in exchange for giving up one third of the property
appreciation to the lender.
◼ The developer is required to pay the lender her share of the
appreciation either in 10 years or when the property sells, whichever
occurs first.
◼ Now suppose the property appreciates 10 percent per year, or doubles
in value over the 10 years.
◼ At the end of year 10
◼ Buyer owes the lender 1/3 of the $7.5mill appreciation ($2.5 mill).

◼ Buyer still has a mortgage balance of $5,365,800.

◼ Problem ?? k s tse 43
 æ1- (1+ 9% /12)- 360 ö
6mill = PMT ç ÷Þ PMT = 48, 277.35
è 9% /12 ø
Example-SAM æ1- (1+ 9% /12)- 240 ö
Balanceyr10 = 48277.35ç ÷= 5, 365, 784.6
è 9% /12 ø

◼ Problem

◼ The total debt ($2,500,000 + 5,365,800) of $7,865,800 exceeds

the original purchase price of the property, and quite likely
the buyer would be forced to refinance the entire $7,865,800
at possibly much higher rate in order to pay off the lender.

k s tse 44
 Advantages and Disadvantages of SAM
◼ The advantage of a SAM to the lender is the ability to
share in any property appreciation.
◼ Property values however, may not appreciate for a long
time.
◼ Some areas may even experience severe losses in
property value.

k s tse 45
 Advantages and Disadvantages of SAM
◼ Questions regarding SAM:
◼ Who determines the price appreciation of the property, the
lender or the borrower?
◼ How to handle property improvements made by the property
owner?
◼ Does the lender also share in any property loss?
◼ Is the appreciation payment made to the lender regarded as
interest income or long-term capital gain? Is it deductible
interest expense or is it subject to capital gain tax?

k s tse 46
SAM: Agency Problem?
◼ How would the borrower manage the property?
◼ Discussion….
Mortgage
Insolvency No Profit Profit Sharing with lender:
Payoffs Bankruptcy Sharing 1/3 of price appreciation

Property
Value
Mortgage Initial
Balance: Property
$5,365,800 Value
$7,500,000
k s tse 47
End
◼ Financing Real Estate

k s tse 48