How Shared Appreciation Loans Can Help Fix the California Dream

July 22, 2022
CA Capital

In a new report from California State Treasurer Fiona Ma’s office prepared by California Forward, California Community Builders, HR&A Advisors, and CSG Advisors, researchers show how the state government can invest in racial justice and housing security by supporting a new form of home loan called a “shared appreciation mortgage” for first-time homebuyers. 

Senator Toni Atkins’ California Dream For All program established a path to pursue fair housing goals with a state investment fund designed to reduce financial barriers for historically disadvantaged communities. The program acts as a form of insurance against the downside risk of home equity investments, creating a shared commitment to reparative justice on the public balance sheet that could have truly transformative impacts if administered effectively.

Key takeaways:

  1. By funding shared appreciation loans (SALs), the California Dream For All program would make major investments in closing the racial wealth gap by assisting first-time homebuyers through a loan that “splits the risk of home price depreciation with homebuyers” and thus reduces monthly payments.
  2. This is particularly critical for racial justice, since homeownership rates have decreased for Black and Latino households, and down payment assistance programs are insufficient for bridging the gap for households with limited savings.
  3. The program must be designed carefully so that taxpayers are not exposed to unexpected risks.

The passage of AB-140 in 2021 included provisions for the Treasurer’s office to report on program design and best practices for the California Dream For All program, a state investment fund for shared appreciation loans to assist first-time homebuyers. SALs are an especially powerful opportunity to expand access to homeownership and close the racial wealth gap in California. 

With SALs, the state could invest in assistance to first-time homebuyers by providing loans for down payments – effectively a form of second mortgage that is tied to the appreciation of the house itself. The borrower only repays the loan when they sell the house, which enables them to borrow at a lower interest rate and greatly reduces their monthly mortgage payments. 

The report found that the program could expand first-time home-buying opportunities by “reducing the monthly payment to a household, while generating revenue to serve future households and providing protection to the homebuyer in the event of depreciation.” Sharing the downside risk is also key to the program’s long-term sustainability. As the report notes, SALs “generate revenue that can be recycled to fund loans for multiple rounds of homebuyers over time.”

As a result of racial segregation in neighborhoods and systemic wage inequality, Black and Latino households in California typically have less money in savings. Without sufficient cash to make a down payment on a home, these communities often rely on riskier financial instruments, with higher borrowing costs – which exacerbate financial inequities

The result: Communities of color are over-exposed to the downside risks of homeownership, such as during the Great Recession of 2008, which was precipitated in part by racially discriminatory subprime mortgage lending. Even today, inequitable access to homeownership remains: “The median-income white household typically requires nine years of savings to afford a 5 percent down payment compared to 14 years for Black households and 11 years for Latino households.”

Solving this problem will require careful program design, since the scale of the need for SALs will vary by location and housing typology. Since home prices vary widely by region, covering a 20 percent down payment may not be enough to help first-time homebuyers in more expensive metros –  even though it would be no less important to assist them; the report recommends covering up to 30 percent down payments in some cases. 

In addition, the program should eliminate common pre-payment penalties: “Prepayment incentives are critical in order to increase the pace of [fund] recycling and the overall impact of the Fund.”

In order to truly build wealth for disadvantaged communities, the report recommends targeting households earning 100% of Area Median Income, up to 150%, with no asset tests. Since these are the households most likely to be “on the cusp of homeownership,” down payment assistance could maximize its impact by targeting this range of incomes.

The report proposes three options for financing the program: 

(1) a revolving loan fund 

(2) state-issued general obligation bonds, and 

(3) a revolving interest fund with revenue bonds. 

Among these options, the third option is the riskiest, because while it removes all risk from the state’s General Fund by borrowing against the program’s anticipated cash flow, “large loan losses … would make it more difficult to sell additional series of revenue bonds and continue funding CA Dream for All loans in this way.” 

In spite of these risks, the structure of SALs makes the program more resilient to economic downturns. As the authors note: “If loan losses are greater than projected, there is no additional financial cost to the State’s General Fund. Rather, the amount of future CA Dream for All lending from loan repayments will be reduced.”Notably, the authors add a major cautious-yet-hopeful caveat: “While a SAL cannot by itself solve the supply-side issues that dramatically impacted housing affordability in California, there may be future opportunities to link shared appreciation to other reforms in order to increase housing supply.” Fortunately, this is addressed in a recent Terner Center report on construction financing for Accessory Dwelling Units.