The John Marshall Law Review

Volume 15 | Issue 1 Article 4

Winter 1982

The Shared Appreciation Mortgage: A Clog on the

Equity of Redemption, 15 J. Marshall L. Rev. 131
(1982)
Lou J. Viverito

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Lou J. Viverito, The Shared Appreciation Mortgage: A Clog on the Equity of Redemption, 15 J. Marshall L. Rev. 131 (1982)

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 COMMENTS

THE SHARED APPRECIATION MORTGAGE: A

CLOG ON THE EQUITY OF
REDEMPTION?
The conventional real estate mortgage' predominantly em-
ployed in the field of residential financing since the 1930s is ob-
solete. 2 We have entered a new era of innovative mortgage
alternatives labeled with unfamiliar acronyms. 3 This shift

1. The standard fixed payment mortgage is the primary instrument in

use in the United States since the 1930s. It provides for a full amortization
over an extended period of time and for equal monthly payments. The pay-
ments consist of both principal and interest, therefore, the proportion of
interest and principal changes with each payment. The interest component
declines and the principal component increases until the entire balance is
repaid. The interest rate is fixed at the inception of the loan and remains
constant over the loan's life. FEDERAL HOME LoAN BANK BOARD, 11 ALTER-
NATIVE MORTGAGE INSTRUMENTS RESEARCH STuDY, Simulation Analysis of
AMIs VIII-3 (Nov. 1977) [hereinafter cited as AMIRS]; BLACK'S LAW Dic-
TIONARY 911 (5th ed. 1979). For a more detailed description of the standard
mortgage, see, e.g., Bartke, The OrganizedBar in Housing and UrbanDevel-
opment, 4 URB. LAw. 206, 212 (1972); Coan, The Housing and Urban Develop-
ment Act o/1968: Landmark Legislation/orthe Urban Crisis, 1 URB. LAw. 1,
2 (1969).
2. The Federal Home Loan Bank Board initiated a major research pro-
ject in 1976 known as the ALTERNATIVE MORTGAGE INSTRUMENTS RESEARCH
STUDY or AMIRS. The AMIRS was designed to provide a comprehensive
analysis of several proposed mortgage instruments. The need for alterna-
tive mortgage instruments stemmed from the inadequacies of the standard
fixed-rate, level-payment mortgage widely in use. The three volume AMIRS
was published in November, 1977.
3. They include inter alia the following: FLIP mortgage (flexible loan
insurance program), the GPM (graduated payment mortgage), the ROM
(roll-over mortgage), the VRM (variable rate mortgage), the DIM (deferred
interest mortgage), and the RAM (reverse annuity mortgage). Alternative
Mortgage Instruments are Building, SAVINGS & LOAN NEWS 51 (Aug. 1977).
The reluctance of savings and loan associations to offer RAMs is discussed
in Chicago Tribune, Aug. 2, 1981, § 14, at 1, col. 1. See also, II AMIRS, supra
note 1, SimulationAnalysis ofAMIs at VIII-3. As a result of the AMIRS, the
Federal Home Loan Bank Board authorized several new forms of mortgage
instruments for federally chartered savings and loan associations. In De-
cember of 1978, the graduated payment mortgage (GPM) and the reverse
annuity mortgage (RAM) were authorized for use in federal associations.
In May of 1979 and April of 1980, respectively, the Federal Home Loan Bank
Board authorized variable rate mortgages (VRM) and renegotiable rate
mortgages (RRM) for use in federal associations. The Chicago Sun-Times,
July 16, 1981, at 73, col. 3, reported that the graduated payment adjustable
mortgage (GPAM), which combines a graduated monthly payment feature
with an adjustable interest rate was authorized on July 15, 1981 for use in
federally chartered savings and loan associations beginning July 22, 1981.
 The John Marshall Law Review [Vol, 15:131

evolved from consumer demand, generated by the inadequacies

of the traditional mortgage, for more flexible mortgage
instruments.
Designed to operate in a relatively stable economy, the stan-
dard long-term mortgage features a fixed interest rate and level
monthly payments. In periods of continued high inflation, 4 how-
ever, most residential lenders are reluctant to invest in long-
term, fixed-rate mortgages because their earnings will not reflect
increases in interest rates which they must offer to depositors to
attract funds. In addition, sharp rises in interest rates adversely
affect borrowers. Many people who otherwise could have be-
come homeowners cannot afford the necessarily high monthly
payments of the conventional mortgage caused, in part, by high
interest rates. These people must continue renting.
The alternative mortgage instruments recently introduced
attempted to ameliorate the inflexibility of the standard mort-
gage by accommodating diverse borrower financial needs and by
permitting lenders to adjust earnings to prevailing economic
conditions. However, these innovations have been unsuccessful
in striking a balance which provides affordable financing for bor-
rowers and also assures lenders a profitable yield. As a result,
the shared appreciation mortgage 5 was proposed by the Federal
Home Loan Bank Board 6 on September 30, 1980, for use by fed-
erally chartered savings and loan associations. 7 The shared ap-
preciation mortgage bears an interest rate below that prevailing
for a conventional mortgage and allows the lender to share in
the anticipated increase in the property's market value. Conse-
quently, the shared appreciation mortgage could eliminate the
problems inherent in the standard mortgage which other alter-
native mortgage instruments have failed to overcome.
This article explores the impact of the economy on home
financing,8 focusing on the need for innovative mortgage instru-

4. One of the early analyses of the inadequacies of the conventional

mortgage in an inflationary economy is BOARD OF
GOVERNORS OF THE FED-
ERAL RESERVE SYSTEM, WAYS TO MODERATE FLUCTUATIONS IN HOUSING CON-
STRUCTION, HOUSING FINANCE UNDER INFLATIONARY HOUSING CONDITIONS 355
(Washington D.C., 1972). For a more recent treatment, see, FEDERAL RE-
SERVE BANK OF BOSTON, NEW MORTGAGE DESIGNS FOR STABLE HOUSING IN
AN INFLATIONARY ENVIRONMENT, Conference Series No. 14 (Jan. 1975).
5. The shared appreciation mortgage is commonly referred to as SAM.
6. The Federal Home Loan Bank Board is an agency of the federal gov-
ernment that regulates federally chartered savings and loan associations.
7. The proposed regulation, presently in draft form captioned 12 C.F.R.
§ 545.6-4b [hereinafter cited as 12 C.F.R. §545.6-4b Draft], is available from:
Information Services of the Office of General Counsel, 1700 G. Street, N.W.,
Washington D.C. 20552.
8. See text accompanying notes 12-23 infra.
1982] Shared Appreciation Mortgage

ments 9 from the perspective of both lenders and borrowers. Fi-

nally, the equitable doctrine against clogging the equity of
redemption' is examined as a potential obstacle to implementa-
tion of the shared appreciation mortgage."

THE NATION'S CHANGING ECONOMIC CLIMATE

The first few years following the end of World War II were
characterized by an attempt to artificially maintain stable inter-
est rates. 12 Unfortunately, the effort proved unsuccessful and
was abandoned. Mortgage interest rates rose sharply, fueled by
the demand for financing of the returning veterans. During the
remainder of the 1950s, the country experienced a slower, but
3
steady, increase in housing interest rates.'
This trend continued into the 1960s and was followed by a
period of unprecedented stability which began in 1961 and con-
tinued through 1965 with interest rates for real estate transac-
tions hovering at six percent. 14 At the same time, the interest
rates offered depositors attracted a surplus of funds, enabling
savings institutions to provide the financing necessary to sup-
port the rapid growth of housing in the United States. 15 Due to
this stability in interest rates, lenders were not concerned with
the imbalance of their financial position created by using short-
term deposits to fund long-term loans. 16

9. See text accompanying notes 24-37 infra.

10. See text accompanying notes 72-94 infra.
11. See text accompanying notes 95-113 infra.
12. The Federal Reserve, in an effort to maintain low interest rates,
bought government bonds at par in the market and let them float to achieve
their own level. After proving unsuccessful, this experiment was termi-
nated by the Federal Reserve Treaty Accord. See, e.g., KLAMAN, THE POST-
WAR RESIDENTIAL MORTGAGE MARKET 84 (1961); SUBCOMM. ON HOUSING OF
THE SENATE COMM. ON BANKING & CURRENCY, A STUDY OF MORTGAGE
CREDIT, 86th Cong., 2d Sess. 197, 283-84 (1960).
13. See REPORT OF THE COrMvISSION ON MORTGAGE INTEREST RATES 21,
Fig. 3 (1969), for a chart showing selected bond and mortgage yields and
FHA-VA interest ceilings for the period of 1950-1969. For a graph showing
the average interest rates on conventional mortgages on existing houses
during the period of 1960-1975, see Vidger, ModeratingInterest Rate Obsoles-
cence and Mortgage Credit Scarcity in Housing Finance, 45 APPRAISAL J.
405, 408 Fig. 1 (1977).
14. See, e.g., A DECENT HOME, THE REPORT OF THE PRESIDENT'S COMMIT-
TEE ON URBAN HOUSING 128 (1968).
15. Kratovil, A New Dilemmafor Thrift Institutions: JudicialEmascula-
tion of the Due-on-Sale Clause, 12 J. MAR. J. PRAC. & PROC. 299, 311 (1979).
For a comparison of the percentage of disposable income saved by Ameri-
cans with savings in West Germany and Japan, see MORTGAGE BANKER,
Feb. 1981, at 33.
16. This imbalance, referred to as the borrowing short, lending long syn-
drome, has been repeatedly documented. See, e.g., Bartke, Home Financing
at the Crossroads- A Study of the Federal Home Loan Mortgage Corpora-
 The John Marshall Law Review [Vol. 15:131

The Plight of the Mortgage Lenders

The economic climate changed abruptly in 1966 when inter-

est rates offered by federal government securities rose dramati-
7
cally to attract funds to finance the mushrooming federal debt.'
Disintermediation, 18 which occurs when depositors withdraw
their money from savings institutions to take advantage of the
higher interest rates offered by other forms of investment,
caused a major drain on lenders' accounts, thereby preventing
them from making new mortgage loans. This situation precipi-
tated the first "credit crisis."' 19 Although interest rates declined
substantially in 1967, they rose again in 1968 and have been gy-
rating ever since. 20 Consequently, the imbalance in the mort-
21
gage lenders' financial position became a principal concern.
Traditional mortgage lenders, particularly the savings and
loan associations, depend upon short-term demand deposits and
certificates as their primary source of funds, which they invest

tion, 48 IND. L.J. 1, 7-9 (1972); Klaman, Public/PrivateApproaches to Urban

Mortgage and Housing Problems, 32 LAw & CONTEMP. PROB. 250 (1967).
17. For a discussion of the experiences of 1966, see, e.g., 53 FED. RES.
BULL. 728 (1967); Cagan, Monetary Policy, ECONOMIC POLICY AND INFLATION
IN THE SIXTIES 89, 117-25 (1972).
18. When free market interest rates exceed the regulated interest
ceiling for time deposits, some depositors withdraw their funds and in-
vest them elsewhere at a higher interest rate. This process is known as
"disintermediation."
BLACK'S LAw DICTIONARY 421 (5th ed. 1979).
19. A review of the "credit crises" of the recent past, including those
that occurred in 1966, 1969-70, and 1974-75 when credit in general and mort-
gage credit in particular was simply not available at any reasonable price to
many qualified borrowers, amply demonstrates the nature and severity of
the cyclical instability of the conventional mortgage finance mechanism. I
AMIRS, supra note 1, AMIRS: An Overview and Summary at 3. A more
detailed discussion is provided in Dall, The Conventional Mortgage-Backed
Security, in FNMA-FHLMC General Counsels' Conference 159-60 (1978).
20. For interest rate figures through 1975, see UNITED STATES SAVINGS &
LOAN LEAGUE, 1976 SAVINGS & LOAN FACT BOOK 35 (1976). Figures for 1976
and 1977, respectively, may be found in 63 FED. RES. Btr. A3 (Jan. 1977); 63
FED. RES. BULL.A3 (July 1977). For long-term trends, see BUREAU OF THE
CENSUS, U.S. DEPT. OF COMMERCE, 2 HISTORICAL STATISTICS OF THE UNITED
STATES, CoLONIAL TIMES TO 1970, Series X474-486, at 1003 (1975).
21. The savings and loan industry has been hurt in two ways: first,
many of its home mortgages return interest at below-market rates, and sec-
ond, depositors have been withdrawing savings in favor of higher interest
elsewhere. This situation threatens the stability of over one-third of the na-
tion's federal savings and loan associations. Chicago Tribune, July 15, 1981,
§ 2, at 2, col. 3. A contrary view is expressed in Chicago Sun-Times, May 8,
1981, at 57, col. 3. For charts showing lender behavior in the last several
years, see 63 FED. RES. BULL. 189, 192-94 (1977). Inflation and high interest
rates have also affected real estate investors. For an analysis, see Wendt,
Inflation and the Real Estate Investor, 45 APPRAISAL J. 343 (1977); Chicago
Sun-Times, May 8, 1981., at 57, col. 1.
19821 Shared Appreciation Mortgage

in long-term, fixed-rate real estate loans. 22 In periods of rising

interest rates, this practice, known as the borrowing short, lend-
ing long syndrome, puts these lenders in a precarious position.
Every time interest rates increase sharply, the savings and loan
associations experience massive withdrawals, creating liquidity
problems which impair their ability to continue making mort-
23
gage loans.
In order to prevent disintermediation and thereby maintain
a supply of funds to support the housing market, lenders must
be able to offer depositors a return greater than that available
from government and other securities. In addition, to keep
mortgage lending institutions solvent, a profitable margin be-
tween the rate offered depositors and that of the lenders' loan
portfolio must be maintained. 24 In short, a financing method
must be found to allow lenders' long-term loans to respond to
increases in interest rates. In an inflationary economy, financial
institutions cannot survive by borrowing short-term and lending
long-term. 25 The inefficiency of the standard fixed-rate mort-
gage in periods of fluctuating, rising interest rates induced by
rapid inflation adversely affects borrowers as well as lenders. 26

22. See, e.g., Bartke. Home Financingat the Crossroads- A Study of the
FederalHome Loan Mortgage Corporation,48 IND. L.J. 1, 6-9 (1972); 63 FED.
RES. BULL. A29, A40 (July 1977).
23. For the fluctuations in the net inflow or outflow of savings see, e.g.,
UNITED STATES SAVINGS & LOAN LEAGUE, 1976 SAVINGS & LOAN FACT BOOK
(1976). The net operating margins of savings and loan associations in times
of sharply rising interest rates are discussed in Advisory Opinion of the
Federal Home Loan Bank Board, Resolution No. 75-647, at 21 (1975), submit-
ted at the request of the court in Schott v. Mission Fed. Sav. &Loan Ass'n.,
Cause No. Civ. 75-366 (C.D. Cal 1975). For a discussion of yield spreads be-
tween conventional mortgages and corporate bonds for the period 1971-76,
see 63 FED. RES. BULL. 189, 192-93 (1977).
24. 63 FED. RES. BULL. 189, 192-93 (1977); Kratovil, A New Dilemma for
Thrift Institutions: JudicialEmasculation of the Due-on-Sale Clause, 12 J.
MAR. J. PRAc. & PROc. 299, 311 (1979). On August 20, the Federal Reserve
Board offered to lend money to savings and loan associations at rates as low
as 14 percent in an attempt to help financially pressed lending institutions.
Sixty percent of the mortgages held by savings and loan associations were
yielding less than 10 percent, yet savings and loans had to pay considerably
more to attract depositors. Chicago Sun-Times, Aug. 21, 1981, at 79, col. 2;
Chicago Tribune, Aug. 21, 1981, § 4, at 11, col. 5.
25. Chicago Tribune, Aug. 21, 1981, § 4, at 11, col. 5. Regulation permit-
ting savings and loan associations to offer higher interest rates on six-
month certificates and yields slightly above the rate on twenty-six month
Treasury bills offer no solution. "Any bank that took that expensive new
money and invested in a 30-year mortgage ... had to be stupid or crazy."
Vincent J. Quinn, president of Brooklyn Savings Bank, as quoted in Wall St.
J., Jan. 2, 1979, at 28, col. 2.
26. I AMIRS, supra note 1, AMIRS: An Overview and Summary, at 2.
 The John Marshall Law Review [Vol. 15:131

The Borrower's Dilemma

Many people cannot afford the necessarily high monthly

payments of the conventional mortgage, caused in part by high
interest rates, and must, therefore, postpone their housing
purchases. 27 Those individuals fortunate enough to become
homeowners may be "house poor" during the initial years of
ownership because of the staggering monthly mortgage obliga-
tion and comparatively low income. Other families find that, be-
cause of prevailing interest rates, they are unable to afford the
28
type of home that meets their long term income expectations.
29
These problems are manifestations of the "financing gap"
caused by the inadequacies of conventional mortgage financing
30
during inflationary periods.
The standard mortgage offers no flexibility for adaptation to
diverse borrower financial requirements, thereby compounding
the housing affordability problem. Specifically, traditional
financing is unable to accommodate changing patterns of family
income3 l and ignores the probable increase in the market value
of the security property. 32 Because the conventional mortgage

27. As home prices and interest rates spiral upward, many potential
homeowners are priced out of the housing market. Only about one in four
American families can afford a new home. BUILDER, May 21, 1979, at 100.
The percentage of first-time home buyers in the United States declined
from 36 percent in 1977 to 18 percent in 1979. MORTGAGE BANKER, Feb. 1981,
at 37. For a comparison of monthly homeownership costs in major metro-
politan areas, including Illinois, see Chicago Sun-Times, Aug. 21, 1981,
(Homelife) at 4, col. 3. An example illustrating the reduction in the percent-
age of families that can afford a home as the interest rate increases is in-
cluded in MORTGAGE BANKING, July 1981, at 38, table 1.
28. I AMIRS, supra note 1, AMIRS: An Overview and Summary at 2.
29. Id.
30. Id. In August, 1979, a borrower obtaining a conventional $60,000
mortgage for 29 years at the 11 percent prevailing rate could look forward to
a fixed monthly payment of $573.98 for principal and interest. Borrowing
the same amount at today's 17.5 percent rate requires initial monthly pay-
ments of $880.72 which may be subject to change if the interest rate is ad-
justable. Chicago Sun-Times, Aug. 7, 1981 (Homelife) at 3, col. 1.
31. Conventional mortgages disregard most buyers' rise in earnings
during their early working years, the more level income pattern of middle-
aged families, and the often declining income of retired or soon to be retired
individuals.
32. The value of the American home went up 113 percent between 1967
and 1977. The average price of unimproved land rose 150 percent in the
same period. Meanwhile, overall inflation was 83 percent. READER'S DI-
GEST, Mar. 1981, at 140. The median price of a new home purchased in 1965
was $20,000. BUREAU OF THE CENSUS, U.S. DEPT. OF COMMERCE, STATISTICAL
ABSTRACT OF THE UNITED STATES 792, No. 1398 (100th ed. 1979). In August of
1977, the average price of a new home was $54,600. Wall St. J., Sept. 9, 1977,
at 4, col. 3. The median cost of a new home in 1980 was $64,600, while the
median cost of a previously owned home stood at $63,000. MORTGAGE BANK-
ING, July 1981, at 33. The median sales price of a new home in January, 1981,
was $67,200. Chicago Tribune, Mar. 4, 1981, § 4, at 1, col. 1.
19821 Shared Appreciation Mortgage

does not operate effectively in today's inflationary economy,

consumers are demanding innovative mortgage instruments
designed to close the "financing gap" by accommodating ex-
pected appreciation of the property and anticipated income in-
creases of the consumers. 33 One viable mortgage alternative is
the shared appreciation mortgage.

THE SHARED APPRECIATION MORTGAGE

Since 1974, several alternative mortgage instruments have

been introduced by the federal government in an attempt to
ameliorate the inflexibility of the standard mortgage. 34 These
alternatives are comprised of variations on the conventional
mortgage which benefit either the lender or the borrower, but
not both. The variable rate mortgage includes a provision per-
mitting the lender to adjust the interest rate in response to eco-
nomic conditions. 35 The graduated payment mortgage, offered
primarily to first-time homebuyers, has scheduled monthly pay-
ments that are initially less than those of a standard mortgage
but which increase annually to reflect anticipated increases in
the borrower's income.3 6 These mortgages, however, have been
unsuccessful in incorporating into a single instrument an afford-
able financing program for borrowers which also assures lenders
a hedge against inflation. 37 Accordingly, the Federal Home Loan
Bank Board, which regulates many of the nation's largest vol-
ume mortgage lenders, has recently proposed a regulation au-
thorizing all federally chartered savings and loan associations to

33. For a brief description of several of the alternative mortgage instru-

ments presently available, see, e.g., I AMIRS, supra note 1, Recommenda-
tions on Alternative Mortgage Instruments at I-1; Alternative Mortgage
Instruments are Building, SAVINGS & LOAN NEWS 51 (Aug. 1977); II AMIRS,
supra note 1, Simulation Analysis of AMIs at VIII-3; McKenzie, A Compre-
hensive Look at Shared-AppreciationMortgages, 13 FED. HOME LOAN BANK
BOARD J. 11, 14 (Nov. 1980) [hereinafter cited as 13 F.H.L.B.B.J.I.
34. 13 F.H.L.B.B.J., supra note 33, at 14. The graduated payment mort-
gage was authorized on an experimental basis by the Housing and Commu-
nity Development Act of 1974. I AMIRS, supra note 1, The HUD-FHA GPM
Experiment at V offers an analysis of the results of the experiment. The
federal government pursues several goals in housing. Principal among
these are the expansion of homeownership opportunities, the assurance of
decent shelter for low and moderate income people, and the encouragement
of a strong housing and mortgage finance industry. BUILDER, May 21, 1979,
at 100.
35. BLACK'S LAw DIcTIONARY 911 (5th ed. 1979); 13 F.H.LB.B.J., supra
note 33, at 14.
36. 13 F.H.L.B.B.J., supra note 33, at 14.
37. 12 C.F.R. § 545.6-4b Draft, supra note 7, at 2. See also 13 F.H.L.B.B.J.,
supra note 33, at 14. Variable rate mortgages are basically for the protec-
tion of the lender. Graduated payment mortgages lower the monthly cost of
homeownership in the early years but will eventually cost the homeowner
more than a conventional mortgage. MORTGAGE BANKING, July 1981, at 33.
 The John Marshall Law Review [Vol. 15:131

participate in marketing shared appreciation mortgages. 3 8 A

shared appreciation mortgage is a residential housing loan in
which the borrower agrees to share the property's appreciation
with the lender in return for the lender's agreement to provide
the financing at an interest
39
rate below that prevailing for a con-
ventional mortgage.
The Federal Home Loan Bank Board's version of the shared
appreciation mortgage 4° bears two distinct elements of interest.
The first element is a below-market interest rate which is fixed
at the loan's inception and is paid over the term of the loan as a
portion of the level monthly payment. The principal and inter-
est are amortized over a period of up to forty years. However,
the shared appreciation mortgage, as proposed, would mature in
a maximum of ten years. 41 Thus, the borrower must repay the
outstanding indebtedness not later than the end of the tenth
year after the origination of the loan. 42

38. 12 C.F.R. § 545.6-4b Draft, supra note 7. For a general discussion of

the shared appreciation mortgage and several variations, see, e.g., 13
F.H.L.B.B.J., supra note 33; Homeowner's Moneyletter, Nov. 1980, at 1-6;
HOUSING, Sept. 1980, at 11; MONEY, Jan. 1981, at 82.
39. CHANGING TIMES, Dec. 1980, at 8; HOUSING, Sept. 1980, at 11. Lenders
discuss the shared appreciation mortgage in MORTGAGE BANKER, April 1981,
at 38. The major criticisms advanced by lenders against the shared appreci-
ation mortgage are set forth in MORTGAGE BANKING, July 1981, at 39.
40. The shared appreciation mortgage that the Federal Home Loan
Bank Board is proposing differs from shared appreciation mortgages pres-
ently in use. Advance Mortgage Corp., the mortgage banking subsidiary of
Oppenheimer & Co., started packaging shared appreciation mortgages in
1980. Under the Advance Mortgage plan, known as the appreciation partici-
pation mortgage, the fixed interest rate will be approximately two-thirds of
the current market rate. The stated interest rate will remain constant for
the full 30 year term of the loan. Additional interest, equaling one-third of
the appreciation in value of the property, is payable when the property is
sold or transferred. If the property is not sold or transferred prior to matur-
ity of the loan, the additional interest becomes due whenever the loan be-
comes due or is paid off. Unlike the Federal Home Loan Bank Board's
proposed shared appreciation mortgage which requires the borrower to pay
the contingent interest not later than 10 years after the loan's inception, the
appreciation participation mortgage does not require the borrower to pay
the additional interest until the loan becomes due, 30 years after its incep-
tion, unless the property is sold or transferred prior to maturity of the mort-
gage. CHANGING TIMEs, Dec. 1980, at 8. Another instrument currently in
use, the equity participation mortgage, (EPM), differs from a shared appre-
ciation mortgage in that the lender can share in a portion of the entire eq-
uity on an EPM, including the down payment, while the lender will only
share in the appreciation above the original purchase price in a SAM. The
procedure used to calculate the lender yield on an EPM is discussed in
MORTGAGE BANKER, Feb. 1981, at 37.
41. Ten years is the maximum permissible term of the shared apprecia-
tion mortgage. According to the proposed regulation, a shorter term is al-
lowable. "The term of the loan shall not exceed 10 years ... " 12 C.F.R.
§ 545.6-4b Draft, supra note 7, at 11.
42. Id. 13 F.H.L.B.B.J., supra note 33, at 11.
1982] Shared Appreciation Mortgage

The second element of interest is "contingent" in nature,

based upon the sharing ratio between the borrower and the
lender43 of the property's "net appreciated value." 44 The per-
centage of the appreciation to be paid to the lender as contin-
gent interest is determined at the loan's inception by
negotiation between the lender and borrower. However, the ac-
tual dollar amount would remain indefinite until the contingent
interest becomes due and payable on the maturity of the loan or
the sale or transfer of the property, whichever is earlier.4 5 If the
borrower has not sold or transferred the property prior to matur-
ity of the shared appreciation mortgage, the proposal requires
the lender to provide refinancing of the outstanding principal in-
debtedness plus the full amount of contingent interest.4 Al-
though the proposed regulation limits the contingent interest to
a maximum of forty percent of the net appreciated value, it does
not establish a formula for relating the below-market fixed inter-
est rate to the percentage of contingent interest.
Thus, a shared appreciation mortgage differs from a conven-
tional mortgage in three significant respects. First, although
both the shared appreciation mortgage and the standard mort-
gage have equal monthly payments based on a long-term amor-
tization schedule, the entire outstanding indebtedness of the
shared appreciation mortgage becomes due and payable no later
than the end of the tenth year. Second, the shared appreciation
mortgage bears a fixed interest rate below that of a conventional
mortgage. Third, unlike standard mortgages, shared apprecia-

43. 12 C.F.R. § 545.6-4b Draft, supra note 7, at 11. See text accompanying
notes 102-09 infra.
44. The term "net appreciated value" means the amount equal to the
difference of (i) the market value of the security property, and (ii) the
sum of (a) the cost of the security property, (b) any expenditure prop-
erly chargeable to capital account (including the cost of improvements
made to the property) under the Code, and (c) the cost of any appraisal
performed pursuant to subparagraph (c) (3) of this section.
12 C.F.R. § 545.6-4b Draft, supra note 7, at 12.
45. For purposes of this section, a sale or transfer shall not include (i)
the creation of a lien or encumbrance subordinate to the shared appre-
ciation mortgage; (ii) the creation of a purchase money security inter-
est for household appliances; (iii) a transfer by devise, descent or
operation of law, upon the death of a joint tenant; or (iv) the grant of
any leasehold interest of three years or less not containing an option to
purchase.
12 C.F.R. § 545.6-4b Draft, supra note 7, at 11.
46. In the event of the maturity of the loan prior to the sale or transfer
of the security property, the association shall offer, without regard to
the forecast of borrower's income, to refinance the outstanding indebt-
edness on the loan, including any contingent interest, . . . under the
terms, conditions and interest rates prevailing for new loans on the se-
curity of homes at the time of such refinancing.
12 C.F.R. § 545.6-4b Draft, supra note 7, at 13.
 The John Marshall Law Review [Vol. 15:131

tion mortgages have a contingent interest feature. At either the

maturity of the loan or the sale or transfer of the property, the
borrower must pay the lender a share of the property's
47
appreciation.

Benefits to Lenders

Since the mid-1960s, the savings and loan industry has been
the largest provider of construction and permanent financing for
residential real estate in America. 48 This same period has been
characterized by volatile interest rate fluctuations accompanied
by rampant inflation. Lenders' ability to continue making fixed-
rate mortgage loans was thus impaired. 49 The shared apprecia-
tion mortgage provides savings and loan associations with a par-
tial hedge against unanticipated inflation. If actual inflation
exceeds expected inflation, the contingent interest yield on a
shared appreciation mortgage will exceed the yield expected
when the loan was originated. 50 In this respect, the shared ap-
preciation mortgage has an inflation adjustment feature which
allows lenders' earnings to reflect economic conditions.

47. For purposes of this section, a shared appreciation mortgage loan

is a loan bearing ... contingent interest not to exceed 40 percent of the
net appreciated value of the security property payable upon the earlier
of maturity or payment in full of the loan or sale or transfer of the se-
curity property.
12 C.F.R. § 545.6-4b Draft, supra note 7, at 11. See also 13 F.H.L.B.B.J., supra
note 33, at 11.
48. 12 C.F.R. § 545.6-4b Draft, supra note 7, at 3.
49. Since life insurance companies and other discretionary lenders have
shown a preference for commercial mortgage investments that share in the
appreciation of the security property, introduction of the shared apprecia-
tion mortgage has the potential of inducing the discretionary lenders to re-
turn to the residential mortgage finance market through the purchase of
interests in pools of mortgages. Increased participation in the market by
discretionary lenders would increase the availability of funds for housing.
See Annot., 16 A.L.R.3d 475 (1967) (validity of agreements to share in the
earnings or income from property in lieu of, or in addition to, interest). Al-
though savings and loan associations would be involved in originating the
shared appreciation mortgages, they may not develop an interest in SAMs
as an investment because of their need for current earnings. Pension
funds, life insurance companies, and other essentially inflation hedging in-
vestors may, however, provide a market for SAMs.
50. The converse is also true, however. If actual inflation is less than
expected inflation, the actual yield on the shared appreciation mortgage will
be less than the expected yield. 13 F.H.L.B.B.J., supra note 33, at 12. The
computation of lender's yield on a shared appreciation mortgage consider-
ing the time value of money is set forth in MORTGAGE BANKING, July 1981, at
39, Table 6. For a table showing the value multiplier that would equate the
desired return with the stated mortgage interest rate as well as the annual
compound rate of appreciation required to achieve the desired rate of re-
turn on a shared appreciation mortgage, see MORTGAGE BANKER, April 1981,
at 33, Table 2.
19821 Shared Appreciation Mortgage

The shared appreciation mortgage reduces the interest rate

risk to lenders in another way. If the contingent interest due
and the outstanding indebtedness are refinanced upon maturity,
rather than paid upon the sale or transfer of the property, the
lender may "bring the loan to market" by charging the prevail-
ing interest rate. The maximum ten year term of the shared ap-
preciation mortgage has the effect of shortening the average
maturity of the lender's mortgage portfolio while preventing
loans from bearing long-term interest rates not commensurate
with that of new mortgage loans. 5 1 The shared appreciation
mortgage's contingent interest feature which directly benefits
lenders is balanced by the benefits which the below-market in-
terest rate offers to borrowers.

Benefits to Borrowers
In periods of high interest rates, the shared appreciation
mortgage's interest rate discount feature and the corresponding
lower monthly payments may allow low and moderate income
households to afford a home.5 2 For example, a standard mort-
gage of $50,000 at 13 percent interest amortized over thirty years
involves a monthly payment of $553.10. The monthly payment
on a corresponding shared appreciation mortgage at 9 1/2 per-
cent is only $420.43. Assuming annual property taxes and insur-
ance of $1,000 and a 25 percent payment-to-income requirement,
the household would need an annual income of $30,549 to qualify
for the 13 percent standard mortgage. In contrast, a yearly in-
come of only $24,181 is necessary to be eligible for the 9 1/2 per-
53
cent shared appreciation mortgage, a reduction of 21 percent.
Accordingly, a substantial number of additional households,
now primarily renters, could qualify for homeownership with a
shared appreciation mortgage. In effect, the shared appreciation
mortgage offers renters an opportunity to get a "foot in the
door." Although the potential homeowner pays the lender with
a share of the property's appreciation, the borrower can own a
home and reap some of the financial rewards and income tax
benefits associated with homeownership.5 4 The shared appreci-

51. If the borrower reftnances the contingent interest in addition to the

outstanding indebtedness, the lender will earn interest at the prevailing
rate on the contingent interest.
52. 13 F.H.LB.B.J., supra note 33, at 11; HousinG, Sept. 1980, at 11.
53. 13 F.H.L.B.B.J., supra note 33, at 11.
54. Id. Home ownership is one of the few forms of investment in
America today that: (1) is helped by inflation; (2) is readily marketable; (3)
can be purchased with 20.1 leverage; and (4) has maintained an almost
yearly increase in value for the last quarter century. Another reason for
buying a home is the tax incentive provided by government to promote
homeownership. Approximately two-thirds of all the long form 1040 returns
 The John Marshall Law Review [Vol. 15:131

ation mortgage is particularly attractive to first-time

homebuyers because it enables them to purchase a home
sooner than would otherwise be possible.

Potential Obstacles to Success

Despite the significant benefits the shared appreciation

mortgage offers lenders and borrowers, the Federal Home Loan
Bank Board's proposed regulation presents several potential
problems. First, the proposal allows the borrower and lender to
negotiate the amount of the interest rate discount, the term of
the loan for amortization and maturity purposes, as well as the
lender's share of the net appreciated value.55 Although the vast
majority of lenders are ethical and problems involving dishon-
esty seldom occur, the borrower is, nevertheless, likely to be at a
serious bargaining disadvantage. Moreover, negotiations
between financial professionals and56
amateurs rarely produce re-
sults favorable to the consumer.
Second, the proposed regulation does not prescribe any re-
lationship between the fixed interest and the percentage of con-
tingent interest; nor does it set a maximum limit on the lender's
overall return on its investment.5 7 Consequently, the monthly
subsidy inherent in the shared appreciation mortgage's dis-
counted interest rate may produce staggering gains for the
lender. Although the contingent interest is limited to 40 percent
of the property's appreciation, the actual dollar amount of con-
tingent interest is unlimited. If the purchaser selected a home

are filed because of the deductions for interest and taxes on the taxpayer's
home. This tax benefit reduces the average home payment from 38 percent
of gross income to 25 percent or less. MORTGAGE BANKING, July 1981, at 31.
See note 109 infra.
The Internal Revenue Service has not decided how it will regard the
portion of the appreciation that the borrower must pay the lender. If that
share is considered profit to the borrower, he may owe capital gains on
money that he is not entitled to keep. However, if the contingent interest is
considered interest paid to the lender, the borrower could get an annual tax
deduction that might exceed his income for the year. Regardless of the de-
termination concerning contingent interest, the borrower would be entitled
to an annual income tax deduction for fixed interest and real estate taxes
paid during the year. Homeowner's Moneyletter, Nov. 1980, at 6.
55. "The contingent interest on the shared appreciation mortgage is
equal to a percentage of the appreciation of the property not to exceed 40%,
as agreed to by the borrower and lender." 12 C.F.R. § 545.6-4b Draft, supra
note 7, at 15.
56. Chicago Tribune, Oct. 12, 1980, § 14, at 4, col. 1.
57. "Although the proposal does not establish a formula for relating the
below-market rate of fixed interest to the sharing ratio for net appreciated
value, the Board anticipates that associations will balance fixed interest and
contingent interest to produce an overall competitive rate of return." 12
C.F.R. § 545.6-4b Draft, supra note 7, at 4.
1982] Shared Appreciation Mortgage

in a rapidly appreciating neighborhood, the return on the shared

appreciation mortgage could be substantially in excess of the
yield which the lender would have realized on a variable rate
mortgage adjusted semi-annually to reflect the prevailing inter-
58
est rate.
Finally, if the contingent interest payable to the lender upon
maturity of the shared appreciation mortgage is refinanced, the
borrower's monthly payment could increase dramatically.
Adding contingent interest to the outstanding indebtedness
would result in a new principal balance considerably in excess
of that of the original loan. The discounted interest rate would
no longer be available and the new mortgage would bear the
prevailing interest rate.5 9 Unless the consumer's income had in-
creased substantially, refinancing both the contingent interest
and the outstanding indebtedness could push the borrower into
default. 60
These potential problems present serious legal obstacles to
successful implementation of the shared appreciation mortgage.
Pursuant to the proposed regulation, a consumer may choose to
contest the validity of an agreement entitling the lender to re-
ceive an unlimited dollar amount of contingent interest. A pro-
debtor court 6 ' might be convinced that the overall result of the

58. Under the new rules approved by the comptroller of the currency on
March 24, 1981, national banks will be able to write home mortgages with
interest rates that can be increased as much as one percent every six
months. There is no overall limit on how much the rate can be increased
over the life of the mortgage. The new rules do not apply to savings and
loan associations however. Roland Barstow, chairman of Bell Federal Sav-
ings and Loan Association, said "If we (federal savings and loan associa-
tions) had that type of loan we'd be back in the mortgage market. We are
afraid of the fixed rate mortgage." Chicago Sun-Times, Mar. 25, 1981, at 80,
col. 2.
On April 23, 1981, the Federal Home Loan Bank Board approved the
adjustable rate mortgage (ARM) for use in federally chartered savings and
loan associations effective April 30, 1981. Changes in the interest rate,
which may be adjusted as frequently as every month according to a federal
index, can be reflected in any of three ways: (1) the monthly payment may
be increased or decreased; (2) the term of the loan may be lengthened or
reduced; or (3) the loan principal may be increased or decreased. Chicago
Sun-Times, April 24, 1981, (Homelife) at 5, col. 2; Chicago Tribune, April 24,
1981, § 4, at 1, col. 1.
59. "Refinancing may be effected using any mortgage instrument other
than the SAM authorized for owner-occupied homes to be made at prevail-
ing market rates for new residential mortgages at the time of refinancing."
12 C.F.R. § 545.6-4b Draft, supra note 7, at 7. See text accompanying notes
102-09 infra.
60. See notes 102-09 infra and accompanying text.
61. The courts have played an active role in development of consumer
protection. Recent literature on the subject is voluminous. See, e.g., Sym-
posium, The Developing Law of Consumer Protection,10 GONZ. L REv. 319
(1975).
 The John Marshall Law Review [Vol. 15:131

transaction is fundamently unfair to the borrower or that the

lender's return on its investment is exorbitant. Various legal
and equitable doctrines may be employed to justify a consumer-
oriented court's refusal to enforce the mortgage contract or its
offensive provisions. 62 The protection that the courts of equity
have historically afforded the mortgagor's right of redemption
presents the principal impediment to the operation of the
shared appreciation mortgage.

THE EQUITY OF REDEMPTION

The modern mortgage originated in England during the

fourteenth century. 63 The transaction consisted of a deed from
the borrower conveying fee simple ownership in the land to the
lender, subject to a condition subsequent which would vest title
in the borrower upon repayment of the debt.64 Thus, the mort-
gagee became the owner of the land just as though a sale had
occurred, subject to two qualifications. First, although the mort-
gagee, as owner, was entitled to immediate possession of the
property, any rents collected by the mortgagee while in posses-
sion were to be applied in reduction of the mortgage debt.
Hence, it became common practice for the mortgagee to permit
the mortgagor to remain in possession until default. 65 Second,
the deed described the mortgage debt and stated a payment
date, known as the law day. The mortgagor had the right to pay
the debt on the law day, thereby defeating the deed and re-
turning ownership to the mortgagor. This provision became
66
known as the defeasance clause.
The common law courts enforced the mortgage as written.
Consequently, if the mortgage debt was not paid promptly on
the law day, the mortgagor's default automatically extinguished
his interest in the land. The mortgagee became the absolute
owner of the fee. 67 Generally, failure to pay the mortgage debt

62. See generally Kratovil, Mortgage Law Today, 13 J. MAR. L. REV. 251,
257 (1980) (unconscionability); Fratcher, Restraints on Alienation of Equita-
ble Interests in Michigan Property, 51 MICH. L. REV. 509, 538 (1953); Com-
ment, Oppressive Bargains: Equity and the Credit Market, 19 VA. L. REV.
594 (1933) (relief from forfeitures); Note, The Basis of Relieffrom Penalties
and Forfeitures, 20 MICH. L. REV. 646 (1922); Annot., 16 A.LR.3d 475 (1967).
63. KRATOViL, MODERN MORTGAGE LAW AND PRACTICE 23 (1972).
64. Id. See, TURNER, THE EQUrrY OF REDEMPTION 18 (1931); Fratcher, Re-
straintson Alienation of Equitable Interestsin Michigan Property, 51 MICH.
L. REV. 509, 539 (1953).
65. Id. KRATOVIL, MODERN MORTGAGE LAW AND PRACTICE 24 (1972). See
Christophers v. Sparke, 37 Eng. Rep. 612 (1820).
66. KRATovuL, MODERN MORTGAGE LAw AND PRACTICE 24 (1972).
67. Id. 1 COKE, INsTrrUTES 205a and Butler's Note 96 to the 13th ed.
(1787).
 1982] Shared Appreciation Mortgage

on the law day resulted in the mortgagor losing his land for inad-
equate consideration since the indebtedness was usually con-
siderably less than the value of the property.
Borrowers who had forfeited their land through default, but
who were subsequently capable of paying the mortgagee, began
to petition the king for assistance. Typically, the petition would
set forth the borrowing of the money, the making of the mort-
gage, the unintentional default in payment, and the resulting
loss of the land. These petitions, which the king referred to the
chancellor to be disposed of equitably and in good conscience,
requested that the mortgagee be ordered to accept the proffered
68
payment and convey the land to the mortgagor.
In the course of the seventeenth century, the court of chan-
cery began to regularly grant relief from these forfeitures, rea-
soning that the return of the outstanding indebtedness with
interest was adequate to compensate the mortgagee from
delayed payment. 69 The mortgagor who had defaulted, thereby
losing all his legal rights in the land, was permitted to sue in
equity for redemption. Upon payment of the debt with interest,
the chancellor would compel the mortgagee to convey the land
to the mortgagor.7 0 Thus an important new right, the equity of
redemption, was born. 71 However, ingenious mortgagees soon
devised various schemes to evade the operation of this devastat-
ing development.

CLOGGING THE EQUrrY OF REDEMPTION

The courts of equity ignored the explicit intention of the

parties when they created the equity of redemption. Techni-
cally, legal title vested absolutely in the mortgagee upon default,
but practically, the mortgagor remained the owner even after
default since he could reacquire the property by exercising his

68. KRATOVIL, MODERN MORTGAGE LAW AND PRACTICE 24 (1972).

69. Fratcher, Restraintson Alienation ofEquitable Interestsin Michigan
Property, 51 MICH. L. REV. 538, 541 (1953).
70. Id. TURNER, THE EQUrrY OF REDEMPTION 17-42 (1931); Master and
Fellows of Emanuel College, Cambridge, v. Evans, 1 Chan. Rep. 18, 21 Eng.
Rep. 494 (1625). A correlative remedy for the mortgagee who wanted his
money was developed by the court of chancery as a necessary corollary to
the creation of the equity of redemption without definite duration. The
mortgagee could sue in equity for foreclosure of the equity of redemption.
The court would enter a decree requiring the debtor to pay by a fixed date
or lose his equity of redemption through sale of the land to satisfy the debt.
How v. Vigures, 1 Chan. Rep. 32, 21 Eng. Rep. 499 (1628).
71. Various theories have been proposed as to the origin and historical
development of the equity of redemption. Williams, Clogging the Equity of
Redemption, 40 W. VA. L.Q. 31, 33 (1933); Coughlin, Clogging Redemption
Rights in Illinois, 3 J. MAR. L.Q. 11 (1938).
 The John Marshall Law Review [Vol. 15:131

right of redemption.7 2 In response to this development, the

mortgagees merely inserted a clause in the mortgage waiving
the mortgagor's redemptive right.7 3 The courts of equity, con-
cerned with substance rather than form, countered this move-
ment by establishing the doctrine against clogging 74 the equity
of redemption. This doctrine voided any agreement contained
in or contemporaneous with the mortgage which purported to
right to redeem without resort to fore-
terminate the mortgagor's 75
closure by the mortgagee.
Although the prohibition against clogging has been charac-
terized in various ways, 76 the most common reference to the
doctrine in the United States is "once a mortgage, always a
mortgage. '77 The essence of the rule is that the parties cannot
by stipulations, however express and positive, render the mort-
gage irredeemable.7 8 The clogging doctrine was developed to
prevent ingenious mortgagees from using their superior bar-

72. KRATOVIL, MODERN MORTGAGE LAW AND PRACTICE 25 (1972); OS-

BORNE, NELSON, & WHITMAN, REAL ESTATE FINANCE LAW 28 (1979).
73. KRAToViL, MODERN MORTGAGE LAW AND PRACTICE 25 (1972); Wy-
man, The Clog on the Equity of Redemption, 21 HARv. L. REV. 459, 469 (1908).
74. The first use of the term clog may be found in Bacon v. Bacon, 21
Eng. Rep. 146 (1639) "[W]here the mortgagee will suddenly bestow unnec-
essary costs upon the mortgaged lands, of purposes to clogg the lands, to
prevent the mortgagor's redemption. .. "
75. The court of chancery would not countenance any provision in a
mortgage which would defeat, clog or fetter the equity of redemption. Lord
Northingham in Vernon v. Bethell, 2 Eden 110, 113, 28 Eng. Rep. 838, 839
(1762). The doctrine against clogging the equity of redemption has been
extensively documented. See, e.g., OSBORNE, HiANDBOOK ON THE LAW OF
MORTGAGES 227-238 (1951); TURNER, THE EQUIrY OF REDEMPTION 175-183
(1931); Annot., 24 A.L.R. 822 (1923); Coughlin, Clogging Redemption Right in
Illinois, 3 J. MAR. L.Q. 11 (1938); Fratcher, Restraints on Alienation of Equi-
table Interests in Michigan Property, 51 MICH. L. REV. 509 (1953); Williams,
Clogging the Equity of Redemption, 40 W. VA. L.Q. 31 (1933); Wyman, The
Clog on the Equity of Redemption, 21 HARV. L. REV. 459 (1908); Note, Clog on
the Right to Redeem, 12 COLUM. L.REV. 627 (1912); Note, The Basis of Relief
from Penalties and Forfeitures, 20 MICH. L. REV. 646 (1922); Note, "Once a
Mortgage,Always a Mortgage," 24 MOD. L.REV. 385 (1961).
76. See Lord Haldane in Kreglinger v. New Patagonia Meat Co., (1914)
A.C. 25 and Lord Davey in Noakes v. Rice, (1902) A.C. 24, 32 for excellent
statements of the various aspects of the clogging doctrine.
77. Bonham v. Newcomb, 23 Eng. Rep. 422 (1683); Newcomb v. Bonham,
22 Eng. Rep. 845 (1681); Newcomb v. Bonham, 23 Eng. Rep. 266 (1681). For a
discussion of the status of the clogging doctrine in the United States, see,
e.g., MacArthur v. North Palm Beach Utilities, Inc., 187 So. 2d 681 (Fla. App.
1966); Humble Oil & Refining Co. v. Doerr, 123 N.J. Super. 530, 303 A.2d 898
(1973); Comment, Due-On-Sale Clauses and Clogging the Equity of Redemp-
tion, 36 WASH. & LEE L. REV. 1121 (1979); 59 C.J.S. Mortgages §§ 817-818
(1949); 55 AM. JUR.2d, Mortgages, Right or Equity of Redemption §§ 510-524
(1971).
78. Lord Davey in Noakes v. Rice, (1902) A.C. 24, 32. See Fogelman, The
Deed Absolute as a Mortgage in New York, 32 FoRDHAM L. REV. 299, 301
(1963); Note, Mortgages-Improvements-Absolute Deed in Lieu of Foreclo-
sure, 31 Mo. L. REV. 312 (1966).
19821 Shared Appreciation Mortgage

gaining position to insert clauses in the mortgage which would

effectively nullify or restrict the operation of the equity of re-
demption. 79 Thus, the focus was on the position of the parties at
the creation of the borrower-lender relationship. Any provision
intended to waive the right of redemption was void and the
mortgagor might redeem as though the clause did not exist.80
Determined mortgagees, seeking to escape the effects of the
clogging doctrine, attempted to disguise restrictions on the right
to redeem. The crudest attempts included clauses limiting re-
demption to a certain time after law day and restrictions as to
who could exercise the right to redeem. 81 Courts of equity
struck down these provisions automatically. Agreements al-
lowing the mortgagee to keep part of the mortgaged property,
redemption being limited to the balance, were also held inva-
lid. 82 Similarly, courts have employed the clogging doctrine to
deny a mortgagee's request for specific performance of an option
to purchase the mortgaged premises entered into at the time of
the loan. 83 As mortgagees became more sophisticated, however,
attempts to waive the right of redemption became less obvious.

79. 27 HALSBURY'S LAWS OF ENGLAND § 243 (3d ed. 1959); MEGARRY &
WADE, THE LAW OF REAL PROPERTY 938 (4th ed. 1975); OSBORNE, HANDBOOK
ON THE LAW OF MORTGAGES 146 (2d ed. 1970).
80. OSBORNE, HANDOOK ON THE LAW OF MORTGAGES 146 (2d ed. 1970);
OSBORNE, NELSON, & WHTMAN, REAL ESTATE FINANCE LAw 29 (1979).
81. 27 HALSBURY'S LAWS OF ENGLAND, § 586 (limitation of right to re-
deem), and § 573 (persons who may redeem) (4th ed. 1980). For decisions
concerning restrictions on the time to redeem, see, e.g., Bradbury v. Daven-
port, 114 Cal. 593, 46 P. 1062 (1896) (four months); Frazer v. Couthy Land
Co., 17 Del. Ch. 68, 149 A. 428 (1929) (three years); Heirs of Stover v. Heirs of
Bounds, 1 Ohio St. 107 (1853) (before a fixed date); Floyer v. Lavington, 24
Eng. Rep. 384 (1714) (life of mortgagor); Price v. Perrie, 22 Eng. Rep. 1195
(1707). Provisions that only the mortgagor himself, as distinct from his ex-
ecutor or heirs, or that only the mortgagor and the heirs male of his body
may redeem were held invalid. See, e.g., Howard v. Harris, 23 Eng. Rep. 288
(1681); Newcomb v. Bonham, 23 Eng. Rep. 266 (1681). The mortgagor could
sell his equitable right of redemption or dispose of it by will. If he died
intestate, the right could be exercised by his heirs.
82. Salt v. Marquess of Northampton, (1892) A.C. 1.
83. Humble Oil &Refining Co., v. Doerr, 123 N.J. Super. 530, 303 A.2d 898
(1973). In Humble Oil, the court addressed the specific issue of whether the
doctrine against clogging the equity of redemption bars a mortgagor's guar-
antor from enforcing an option to purchase the property taken from the
mortgagor as part of the original mortgage transactions. Id. at 540, 303 A.2d
at 906. Relying on the clogging doctrine, not specifically pleaded, the court
concluded that the equity of redemption was clogged and denied specific
performance of the option provision to the guarantor. Id. at 540-44, 303 A.2d
at 906-08. See, e.g., MacArthur v. North Palm Beach Utilities, Inc., 187 So. 2d
681 (Fla. App. 1966); Wilson v. Fisher, 148 N.C. 535, 62 S.E. 622 (1908); Note,
20 COLUM. L. REV. 920 (1920); Annot., 10 A.L.R.2d 231 (1950) (option executed
simultaneously with mortgage for purchase of mortgaged property by mort-
gagee as subject of specific performance).
 The John Marshall Law Review [Vol. 15:131

Stipulations providing for an increase in the interest rate

upon default presented a more subtle clog of the equity of re-
demption. If the higher rate was fixed at the inception of the
mortgage with a reduction for punctual payment, the agreement
was valid.8 4 However, if the rate was not specified at the outset,
the agreement failed since the jump in the interest rate upon
default could be so enormous that, as a practical matter, the
mortgagor would be unable to pay it. A provision which does
not specify the higher rate would be recognized as merely a de-
vice to render the mortgage irredeemable and therefore a viola-
tion of the clogging doctrine. 85 The same rationale applies to a
clause entitling the mortgagee to a bonus upon redemption.
Further, a stipulation that unpaid interest will be capitalized
86
and interest paid on it has also been held void.
These decisions are predicated upon a principle which un-
derlies relief from penalties and forfeitures. 87 The gist of the
principle is that relief will be granted where there has been reli-
ance upon a "mirage of hope." The courts have interceded be-
cause of solicitude for the "impecunious landowner" 88 or
"necessitous men [who] are not, truly speaking, free men."8 9
Another significant influence on the court's decision to grant re-
lief is the mortgagee's tendency to take advantage of the mortga-
gor's optimism - the "overconfidence in one's own capacities
and faith in a special providence ... [that] leads us to over-san-
guine commitments." 90 Accordingly, where the agreement in-

84. Strode v. Parker, 23 Eng. Rep. 804 (1694); Holles v. Wyse, 23 Eng.
Rep. 787 (1693). See Salt v. Marquess of Northampton, (1892) A.C. 1, 19;
Firth, Freedom of Contract in Mortgages, 11 L.Q. REV. 144, 153 (1895). See
also Goodyear Shoe Mach. Co. v. Selz, Schwab &Co., 157 111. 186, 41 N.E. 625
(1894).
85. OSBORNE, NELSON, & WHITMAN, REAL ESTATE FINANCE LAw 30 (1979).
86. HALSBURY'S LAWS OF ENGLAND, § 590 (4th ed. 1980) (bonus upon re-
demption); Chambers v. Goldwin, 32 Eng. Rep. 600 (1804) (capitalization of
interest).
87. Note, The Basis of Relieffrom Penaltiesand Forfeitures,20 MICH. L.
REV. 646 (1922). Finger v. McCaughey, 114 Cal. 64, 45 P. 1004 (1896) (in-
crease from ten to twelve percent in the mortgage interest rate valid if not
paid).
88. "[I]mpecunious landowner in the toils of a crafty money lender."
Samuel v. Jarrah Timber & W. P. Corp., (1904) A.C. 323, 327.
89. [A] mortgagee can never provide at the time of making the loan
for any event or condition on which the equity of redemption shall be
discharged, and the conveyance absolute. And there is great reason
and justice in this rule, for necessitous men are not, truly speaking, free
men, but, to answer a present exigency, will submit to any terms that
the crafty may impose upon them.
Lord Northington in Vernon v. Bethell, 2 Eden 110, 113,28 Eng. Rep. 838, 839
(1762).
90. Note, The Basis of Relieffrom Penalties and Forfeitures,20 MICH. L.
REV. 646, 647 (1922).
1982] Shared Appreciation Mortgage

cludes a future increase in the amount due for which the

mortgagor never expects to become liable, the transaction is in-
valid. 9 1 Conversely, an initial firm commitment to a higher rate
which the mortgagor knows he has bound himself to pay, but
which may be reduced by future effort, would not violate the
clogging doctrine.
Two other concepts have occasionally been used to explain
the rule against clogging the equity of redemption. The first con-
cept provides that the mortgagee shall not exact a "collateral ad-
vantage" from the mortgagor. This approach derives from the
phraseology that a mortgagee "shall not have interest for his
money and a collateral advantage besides for the loan of it, or
clog the redemption with any by-agreement. '92 The second con-
cept states that there must be no stipulation in the mortgage
which will "fetter" the property on redemption. In sum, this the-
ory means that "the mortgagee shall not make any stipulation
which will prevent a mortgagor, who has paid principal, interest,
mortgaged property in the condition in
and cost, from getting his'93
which he parted with it."
Although the "collateral advantage" and "fettering" aspects
of the clogging doctrine have played a significant role in English
law, they have never flourished in the United States. Some com-
mentators have expressed concern that these concepts might be
adopted from the English decisions.9 4 Nevertheless, the maxim
"once a mortgage, always a mortgage," commonly associated
with the clogging doctrine in America, encompasses most at-
tempts to defeat the right of redemption. It may also be applied
to the potential clog in the shared appreciation mortgage.

91. OSBORNE, NELSON, & WHrrMAN, REAL ESTATE FINANCE LAw 30 (1979).
92. This aspect of the clogging doctrine can be traced to a statement in
Jennings v. Ward, 23 Eng. Rep. 935 (1705). Relief from a collateral advan-
tage will only be granted in cases of oppression and unconscionable advan-
tage. Kreglinger v. New Patagonia Meat &Cold Storage Co., (1914) A.C. 25.
See 27 HALSBURY'S LAWS OF ENGLAND, § 587 (4th ed. 1980) (collateral bene-
fits as clogs); Williams, Clogging the Equity of Redemption, 40 W. VA. L.Q.
31, 49 (1933) (instances when the courts have upheld collateral advantages).
93. Opinion of Lord Davey in Noakes & Co. v. Rice, (1902) A.C. 24, 33.
The fettering aspect of the clogging doctrine originally invalidated any bar-
gain binding the mortgaged property beyond the redemption period. How-
ever, relief will no longer be granted if the provision is reasonable and is
part of an independent legitimate business agreement, even though the
agreement is conditioned upon the giving of a mortgage at the same time
the agreement is entered into. Kreglinger v. New Patagonia Meat &Cold
Storage Co., (1914) A.C. 25.
94. OSBORNE, HANDBOOK OF THE LAW OF MORTGAGES 145 (2d ed. 1970);
Williams, Clogging the Equity of Redemption, 40 W. VA. LQ. 31, 52 (1933).
 The John Marshall Law Review [Vol. 15:131

THE SUSPECTED CLOG IN THE SHARED APPRECIATION MORTGAGE

Certain aspects of the clogging doctrine can be dismissed as

inapplicable to the shared appreciation mortgage. The Federal
Home Loan Bank Board's proposed regulation does not purport
to waive the mortgagor's equity of redemption 95 or limit the
right to redeem to a certain time after default. 96 Nor does the
proposal impose restrictions as to who may exercise redemptive
rights 97 or grant the mortgagee an option to purchase the prop-
erty securing the loan.98 However, the guaranteed refinancing
provision, 99 which may result in future increases in the mortga-
gor's financial burden, could cause the shared appreciation
mortgage to run afoul of the clogging doctrine.
The proposed regulation provides for guaranteed refinanc-
ing by the savings and loan association that originated the
shared appreciation mortgage if the property securing the loan
is not sold or transferred prior to maturity. 0 0 The outstanding
principal indebtedness plus the full amount of contingent inter-
est may be refinanced without regard to the forecast of the bor-
rower's income. The new mortgage would be financed at the
prevailing interest rate over a minimum of thirty years. I0 '
The clog inherent in the guaranteed refinancing provision is
best illustrated by an example of the possible result of the
shared appreciation mortgage upon maturity. Suppose that the
borrower obtained a $50,000 shared appreciation mortgage to
finance the purchase of a $62,500 home, agreeing to share one-
third 0 2 of the property's appreciation with the lender in return

95. See text accompanying notes 72-75 supra.

96. See text accompanying notes 81-82 supra.
97. Id.
98. See text accompanying note 83 supra.
99. 12 C.F.R. § 545.6-4b Draft, supra note 7, at 13.
100. In the event of the maturity of the loan prior to the sale or transfer
of the security property, the association shall offer, without regard to
the forecast of borrower's income, to refinance the outstanding indebt-
edness on the loan, including any contingent interest .... under the
terms, conditions and interest rates prevailing for new loans on the se-
curity of homes at the time of such refinancing. Any refinancing offered
pursuant to this paragraph shall be for a term of not less than 30
years.... The association may require as a condition of refinancing
that any intervening lien or encumbrance arising between the origina-
tion of the shared appreciation mortgage and the time of refinancing be
released of record of subordinated to the mortgage or deed of trust se-
curing the refinancing.
12 C.F.R. § 545.6-4b Draft, supra note 7, at 13.
101. Id.
102. Although the lender in the example is entitled to only one-third of
the property's appreciation, the proposed regulation allows the lender to
receive up to forty percent of the net appreciated value of the security prop-
erty. 12 C.F.R. § 545.6-4b Draft, supra note 7, at 11.
19821 Shared Appreciation Mortgage

for a 9 1/2 percent interest rate rather than the prevailing rate of
13 percent. 10 3 After ten years,10 4 assuming annual appreciation
of 10 percent, 10 5 the property would be worth $162,109. The
lender's share of the $99,609 in appreciation, i.e., contingent in-
terest, would equal $33,203.106 If the outstanding principal in-
debtedness of the original loan plus the contingent interest are
refinanced over thirty years 10 7 at 13 percent interest, 0 8 the bor-
rower's monthly payment would increase from $420.43 to
$866.22.1o9

103. Although the interest rate used in the example is thirteen percent,
that figure is conservative in comparison to the rates presently prevailing.
As of March 20, 1981, interest rates for residential financing in the Chicago,
Illinois market ranged from 15 1/4 percent to 18 percent. Chicago Sun-
Times, Mar. 20, 1981, at 68, col. 3. On August 21, 1981, interest rates charged
by major lenders for home loans in the Chicago market ranged from 17 to 18
1/2 percent. Chicago Sun-Times, Aug. 21, 1981, [Homelifel at 4, col. 4.
104. The appreciation is calculated as of the tenth year because that is
the maximum permissible term of the shared appreciation mortgage. Con-
tingent interest becomes due and payable upon maturity of the loan unless
the property has been sold or transferred prior to that time. 12 C.F.R.
§ 545.6-4b Draft, supra note 7, at 11. See text accompanying notes 40-46
supra.
105. According to the National Association of Realtors, the national in-
crease in home prices in 1980 was 11.7 percent. Chicago Tribune, April 3,
1981, at 1, col. 5. The value of the average American home went up 113 per-
cent between 1967 and 1977. READER'S DIGEST, Mar. 1981, at 140.
106. The calculations of the property's appreciated value, the net appre-
ciation, and contingent interest were rounded to the nearest dollar in the
example. The actual figures are: appreciated value-$162,108.87; net appreci-
ation-$99,608.87; and contingent interest-33,202.95. Although the amount of
contingent interest the lender is entitled to receive may initially appear to
be unreasonable, it must be balanced against the deferred interest the
lender is entitled to; i.e., the difference between the below-market rate and
the rate prevailing at the loan's inception, and the risk the lender assumed;
i.e., the possibility of the property depreciating in value or failing to keep
pace with inflation.
107. The minimum period for refinancing offered pursuant to the guaran-
teed refinancing provisions of the proposed regulation is thirty years. 12
C.F.R. § 545.6-4b Draft, supra note 7, at 13. Lenders will undoubtedly be
hesitant to exceed the minimum requirement.
108. Based on present long term interest trends, the possibility that the
interest rate prevailing upon maturity of the shared appreciation mortgage
will be the same as that prevailing when the loan was originated is remote.
For long term trends, see BUREAU OF THE CENSUS, U.S. DEPT. OF COMMERCE,
2 HISTORICAL STATISTICS OF THE UNITED STATES, COLONIAL TIMES TO 1970,
Series X474-86, at 1003 (1975).
109. 13 F.H.L.B.B.J., supra note 33, at 13. The increase in the borrower's
monthly mortgage payment upon refinancing is in excess of 106 percent.
George W. DeFranceaux, chairman of the National Housing Partnership
predicts that by 1990 it will be commonplace for American households to
pay 40 percent of their annual income for housing costs. Chicago Tribune,
Mar. 27, 1981, § 3, at 13, col. 2. A Chicago area resident considering the
purchase of an average-priced home should expect to pay over $1000 a
month for 1981 homeownership costs as compared to $594 per month in 1978.
Chicago Sun-Times, Aug. 21, 1981, [Homelife] at 4, col. 3. Three years ago
the average housing cost took approximately 22 percent of a family's gross
 The John Marshall Law Review [Vol. 15:131

Thus, many of the households with shared appreciation

mortgages may experience financial difficulty when the loan is
refinanced. When housing prices increase dramatically most
homeowners may realize only nominal income growth; the low
and moderate income households that qualified for a shared ap-
preciation mortgage are not likely to experience the substantial
increase in earnings necessary to afford the new payment bur-
den. This failure of income to increase in proportion to the in-
crease in monthly payments upon refinancing could push the
homeowner into default. 10
Mortgage terms which suggest that the mortgagee has taken
advantage of the mortgagor's tendency to overestimate his fu-
ture financial capabilities have been interpreted by courts of eq-
uity as clogs on the equity of redemption."' The guaranteed
refinancing provision of the shared appreciation mortgage ap-
pears designed to exploit this human failing. 112 The amount of
contingent interest could be so enormous or the prevailing inter-
est rate upon maturity so burdensome that, as a practical mat-
ter, the mortgagor would be unable to afford the property. Thus,
because the guaranteed refinancing provision is expressed in
terms of an undeterminable future increase in the amount of
contingent interest due, the agreement may be merely a device
to render the mortgage irredeemable and, therefore, in violation
of the clogging doctrine.
The refinancing provision also allows the lender to include
the entire amount of contingent interest in the amount of the
new mortgage together with the outstanding principal balance
of the original loan. Similar provisions, where accrued unpaid
interest has been added to principal, have been held void by the
courts of equity as a clog on the equity of redemption. 113 Conse-
quently, a borrower who chooses to contest the validity of the
shared appreciation mortgage may persuade the court that the
guaranteed refinancing provision was designed to lure an im-

income; shelter currently consumes 38 percent of a family's income. MORT-

GAGE BANKING, July 1981, at 31.
110. Real family income declined 5.5 percent in 1980 according to a Cen-
sus Bureau report issued August 20, 1981; double-digit inflation and the 1980
economic slump were responsible for the drop in median income, the larg-
est plunge ever recorded. Chicago Tribune, Aug. 21, 1981, at 1, col. 4; Chi-
cago Sun-Times, Aug. 21, 1981, at 1, col. 2. The effects of the current
recession on the rate of mortgage delinquencies is discussed in Chicago
Tribune, June 8, 1981, § 4, at 9, col. 2.
111. OSBORNE, HANDBOOK ON THE LAW OF MORTGAGES 147 (2d ed. 1970);
Note, The Basis of Relief from Penalties and Forfeitures, 20 MICH. L. REV.
646, 647 (1922).
112. See text accompanying notes 84-91 supra.
113. Chambers v. Goldwin, 32 Eng. Rep. 600 (1804).
19821 Shared Appreciation Mortgage

provident mortgagor into a commitment which would inevitably

lead to the loss of the mortgaged property.
Despite the similarity between the guaranteed refinancing
provision and mortgage clauses that are held to clog the equity
of redemption, ". . . Courts must not lose sight of the dominat-
ing principle underlying the reasons which originally influenced
the terms of the rule, reasons which have, in certain cases, be-
come modified as public policy has changed.""14 To allow an an-
cient interpretation of the clogging doctrine to impede the
success of the modern shared appreciation mortgage would
twist the equitable principle of avoidance of oppressive, uncon-
scionable, or sharp bargains beyond recognition. The solution to
overcoming the suspected clog in the guaranteed refinancing
provision must, like the shared appreciation mortgage itself, bal-
ance the interests of lenders and borrowers. Federal preemp-
tion of state laws against clogging the equity of redemption
might protect lenders but would not alleviate the financial diffi-
culty many borrowers will experience upon maturity of the
shared appreciation mortgage." 5 Conversely, limiting the dollar
amount of contingent interest that the lender is entitled to re-
ceive may resolve the borrowers' problems but would return
lenders to the same economic treadmill that they attempted to
6
escape by avoiding fixed-rate loans."
The violation of the clogging doctrine inherent in the shared
appreciation mortgage stems primarily from the uncertainty of
the dollar amount of contingent interest which will be due upon
maturity. This lack of specificity, though necessary to the opera-
tion of the mortgage, involves risk to the lender as well as to the
borrower. If the property's value has not increased substan-
tially, the borrower will probably not experience financial
problems upon refinancing. The lender, however, will not real-
ize. the earning expected and may incur a loss due to the below-
market interest of the original loan. The consumer will be in
jeopardy only when the property has considerably appreciated.
At worst, upon default, the property would be sold pursuant to

114. Kreglinger v. New Patagonia Meat &Cold Storage Co., (1914) A.C. 25,
44.
115. Federal law plays a significant role in mortgage financing. For exam-
ple, interest rate ceilings set by state usury laws were preempted under
section 501 of the Depository Institutions Deregulation and Monetary Con-
trol Act of 1980, Pub. L. No. 96-221, 94 Stat. 132. The new rules approved
March 24, 1981 by the comptroller of the currency allow national banks to
write home mortgages with interest rates that can be increased as much as
one percent every six months. These federal rules preempt state laws
which prohibit or limit adjustable rate home loans. Chicago Sun-Times,
Mar. 25, 1981, at 80, col. 2.
116. See text accompanying notes 17-26 supra.
 The John Marshall Law Review [Vol. 15:131

foreclosure and the borrower would receive the proceeds in ex-

cess of the outstanding indebtedness and the contingent inter-
7
est due."
However, since default is unlikely unless the property's
value has risen significantly, the amount of the proceeds that
the borrower could receive from a foreclosure sale might be suf-
ficient to enable him to purchase another home. Consequently,
the problems arising upon refinancing would be alleviated by al-
lowing the borrower, who could no longer afford the property, a
grace period after maturity to sell the property. Alternatively,
the property could be appraised at regular intervals prior to ma-
turity. The borrower would be informed of the new financial
burden based upon the appraised value and given an opportu-
nity to refinance the property at each interval. Finally, lenders
could be required to provide applicants with a detailed disclo-
sure of the differences between the shared appreciation mort-
gage and other available forms of financing, including an
estimate of the borrower's monthly payments upon refinancing.
Armed with this information, the borrower would be in a posi-
tion to make an intelligent decision on the merits of using a
shared appreciation mortgage to finance his home purchase.

CONCLUSION

"Events shape the law."" 8 Although the conventional mort-

gage operated effectively when the nation's financial climate
was stable, in today's inflationary economy it has been unable to
provide prospective homeowners with affordable financing
while assuring lenders a hedge against unanticipated inflation.
Innovative mortgage instruments designed to accommodate
diverse financial requirements of borrowers and lenders are
desperately needed to provide the funds necessary to revitalize
the housing industry. The shared appreciation mortgage offers
borrowers and lenders alike an opportunity to participate in the
realization of the American dream of home ownership." 9

117. The lender's interest in the foreclosure sale would not be adverse to
the borrower since the dollar amount of contingent interest the lender
would receive would increase as the bidding on the property increased. The
borrower would thus have some assurance that the property would be sold
at market value.
118. Kratovil, Mortgage Law Today, 13 J. MAR.L. REV. 251, 271 (1980).
119. There is a presumption that once a person owns a home, quality of
life will dramatically improve and children, raised in a home with grass and
trees, will have a better life. In essence, a home is a place to call one's
own-the proverbial castle, the refuge from turmoil. MORTGAGE BANKING,
July 1981, at 31.
19821 Shared Appreciation Mortgage

There is no question that mortgagors originally needed

more protection than they received. 120 However, early decisions
on clogging the equity of redemption were handed down under
circumstances markedly different from those of the present. Re-
sponsible, honest, and skillful lenders provide certainty in mod-
ern mortgage transactions which was not present when the
majority of mortgage lenders were individuals rather than
financial institutions.
The doctrine against clogging the equity of redemption
evolved in the courts in response to the litigated problems of the
times. Like other rules proceeding from equitable principles,
where the reason for the rule ceases, the principle fails of appli-
cation. 121 Thus, as times change, the rules must yield to the re-
ality of present conditions.
As a result of today's inflationary economy, many prospec-
tive buyers are prohibited from purchasing homes. However, in-
22
flation, when harnessed by the shared appreciation mortgage,
can be a strong ally in assisting the American public to achieve
homeownership. Accordingly, absent precedent addressing to-
day's novel issues, a borrower should not be protected to the
point that he or she can no longer afford to own a home and
must continue renting under the guise of consumer
123
protection.

Lou J. Viverito

120. For a discussion of the law of consumer protection, see, e.g., Sympo-
sium, The Developing Law of Consumer Protection, 10 GONZ. L. REV. 319
(1975).
121. Annot., 24 A.L.R. 822, 823 (1923).
122. MORTGAGE BANKiNG, July 1981, at 41.
123. Kripe, Consumer Credit Regulation: A Creditor-Oriented View-
point, 68 CoLUM. L. REv. 445, 468-69 (1968).