Buying a Home with a Shared-Equity Mortgage
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With housing markets across the nation heating up, buying a first home is becoming more and more difficult for lower and middle-income earners. However, city and regional nonprofits along with private market innovators are trying to make homebuying more accessible through down payment loans called shared-equity mortgages. These mortgages help aspiring homeowners struggling to save a down payment, and they require no monthly payments as long as you live in the home.
What’s the catch? The lender will take a share of the increased value of your home when it comes time for you to sell it. Are shared equity mortgages worth the cost, and will they really help you buy a house? This article explains when it makes sense to buy a house with a shared-equity mortgage.
- What is a shared-equity mortgage?
- How a shared-equity mortgage works
- Who can get a shared-equity mortgage?
- Pros of shared-equity mortgages
- Cons of shared-equity mortgages
- Other options to consider before getting a shared-equity mortgage
- Is a shared-equity mortgage right for you?
What is a shared-equity mortgage?
Shared-equity mortgages (also called shared appreciation mortgages) are mortgages where the mortgage issuer acts as both a lender and an investor. In a shared-equity mortgage arrangement, the homebuyer sells a percentage of their property (including future gains in property value) to the lender in exchange for a reduction in the size of their loan.
Shared-equity mortgages where the lender acts as both a lender and an investor are uncommon in the U.S. In fact, we found only one company, OWN home finance, that issues shared equity mortgages as both the lender and the investor.
However, the shared equity model isn’t completely lost in the U.S. marketplace. Today, private investors and municipal governments use the shared equity model to issue down payment assistance loans. Borrowers use the proceeds from a shared-equity mortgage to make a larger down payment. The shared-equity mortgage (or shared equity investment) allows a homebuyer to reduce the size of their monthly mortgage payment. In some cases, the loans allow borrowers to avoid costly fees like private mortgage insurance (PMI).
How a shared-equity mortgage works
Although shared-equity mortgages can take different forms, the most common form in the U.S. is as a down payment assistance loan. Homebuyers use the loan to make (or increase the size of) a down payment for a home.
Borrowers make no payments on the loan until they sell or refinance their home. At that time, borrowers repay the principal value of the loan plus a percentage of the increased value (appreciation).
Publicly funded loans offer generous shared equity terms for borrowers. Most public loans require borrowers to split the appreciation based on the city’s loan portion of the original sales price. For example, a city that issues a $20,000 loan to pay for a $200,000 house, has a 10% stake in the the home’s appreciation. Seven years later, when the homeowner sells the house for $250,000, the house has gained $50,000 in appreciation. Upon the sale of the home, the seller will repay the $20,000 loan plus $5,000 (10% of the total appreciation) to the city.
Private investments aren’t nearly as generous. When Unison puts in 10% for a down payment, for example, it expects 35% of the appreciation. OWN Home Finance expects a 25% share of appreciation when it puts down 10% of the purchase price.
An example of shared-equity mortgage may look like this:
A lender extends a $20,000 shared equity mortgage on the purchase of a $200,000 house. The homebuyer also puts down $20,000.
The shared-equity mortgage has a $0 monthly payment, but the lender will take 35% of the property’s appreciation when the buyer sells.
What happens when the person buys the house?
|Buying the home|
|Source of money||Amount|
|Down payment for buyer||$20,000 (From buyer’s savings)|
|Down payment from shared-equity investor||$20,000 (As shared equity mortgage)|
|Conventional mortgage||$160,000 (30 years, 4.5% APR)|
|Total purchase price||$200,000|
Since the homeowner has 20% equity in the house, their total mortgage payment is $810.70 plus the cost of taxes, insurance and association dues.
What happens when the person sells the home?
Seven years later, the borrower sells the home for $250,000. The borrower will also have to pay off the remaining principal value of the conventional mortgage, and the principal value of the shared-equity mortgage. She will also have to pay 35% of the appreciation to the shared equity investor. The total disbursement of funds will look like this:
|Selling the home|
|Source of money||Amount|
|Conventional mortgage payoff||-$139,000 (reduced from $160,000 initial mortgage thanks to seven years of payments)|
|Shared-equity mortgage principal payoff||-$20,000 (return of initial investment to investor)|
|Shared-equity investor’s share of appreciation||-$17,500 ($250,000 Sales price – $200,000 purchase price = $50,000 in appreciation. Investor gets 35% of appreciation, or $17,500)|
|Total remaining cash for person selling the home||$73,500|
Who can get a shared-equity mortgage?
Many shared-equity mortgages are loans offered by city or regional governments. These loans are designed to make homeownership affordable for lower and median income earners. That means that many shared-equity mortgages are limited to middle- or lower income borrowers that meet certain need-based standards.
For example, San Francisco’s Downpayment Loan Assistance Program (DALP) is only available to first-time homebuyers (haven’t owned in at least three years) who earn less than 175% of the area’s median income (based on household size). In Austin, The Down Payment Assistance Program is available for buyers who haven’t owned a house in at least three years and who earn 80% or less of the area’s median income.
However, not all shared-equity mortgages are issued by government lenders. Private investment companies, such as OWN Home Finance and Unison, are allowing people of all income levels to use shared-equity arrangements.
OWN Home Finance is a shared-equity mortgage where they issue the mortgage and maintain a share of the equity.
In contrast, Unison’s HomeBuyer is a co-investment product allows homebuyers to double the size of their down payment. People who invest with Unison will need to take out a conventional mortgage from another lender. Michael Micheletti, director of corporate communications for Unison explained, “Across the board, people looking to buy a home are under-saved, and the credit markets are still tight. We realized that shared-equity investing could help buyers increase their purchasing power and get all the benefits of homeownership without taking on all the risk themselves.”
Counterintuitively, shared-equity mortgages are a great deal when housing prices fall as you actually owe your shared-equity lender less than you borrowed from them. This means you get all the benefits of lower monthly payments and a larger down payments, while paying back less than you initially borrowed. Of course, you may still owe the shared-equity investor some money, which will come out of your pocket. This could leave you with no money for a down payment on your next home.
By contrast, shared-equity loans end up being a costly option when housing prices rise rapidly. As the homeowner, you get some of the upside benefit of rising prices, but up to half of the benefit goes to the lender. With so much money going to the lender, you don’t get to fully enjoy the benefits of rising prices. In particular, you may struggle to build wealth (especially during times when the stock market or other investments don’t perform well).
Pros of shared-equity mortgages
Increases buying power: With the help of a shared-equity mortgage, homebuyers can afford to buy more expensive property without raising their monthly costs. This can be especially important for lower income buyers who may not be able to afford homeownership without this type of assistance.
Access prime interest rate: Being able to scrounge up a larger down payment makes it possible to get a lower interest rate on a loan.
Eliminate private mortgage insurance (PMI): PMI is a fee that borrowers have to pay unless they have at least a 20% equity stake in their property. Many people taking out shared equity mortgages can combine their personal savings and the mortgage to get to a 20% down payment. Depending on the size of your mortgage, you could save a thousand dollars or more per year by eliminating this cost.
Reduce monthly mortgage payment: Shared-equity mortgages decrease the size of your loan, but they don’t require monthly payments. That means that your total monthly mortgage payment shrinks substantially. Combined with better interest rates and no PMI, the shared-equity mortgage could save you up to a few hundred dollars each month.
Reduce downside risk: When you put a large down payment on a house, you run the risk that you could lose all your money if you have to sell into a housing downturn. A shared equity-mortgage allows homebuyers to share the risk with an investor who also loses money if the house loses value.
Cons of shared-equity mortgages
Limits wealth-building potential: Sharing the appreciation of a home with an outside investor limits the financial gains from homeownership. If you cannot offset these losses through savings and investments outside of your home, you may struggle to build wealth.
Could cost more than conventional mortgage: When the housing prices rise rapidly, shared-equity mortgages cost homebuyers a lot of money. No money comes out of your pocket while you live in the house, but a large portion of the gains go to the co-investor when you sell the house. The total cost of a shared-equity mortgage could be much more than a cost of a conventional mortgage (even with PMI).
Limited eligibility: The best shared-equity programs are offered by city or municipal governments, not the private sector. However, these programs are only available to city residents who meet certain income criteria. That means that the best programs aren’t open to everyone.
Not many options: With so few companies working in the shared-equity mortgage space, it’s tough to know whether you’re getting a good deal. Since you can’t compare many options, you face a “take it or leave it” decision when it comes to taking out a shared-equity mortgage. Without comparing options, you have to decide whether giving up a third of your appreciation is worth the upfront benefits.
Other options to consider before getting a shared-equity mortgage
Shared-equity mortgages aren’t the only financial products aimed at keeping homeownership affordable. In addition to buying a house with a shared-equity mortgage, you may want to consider one of these options.
Low down payment loans: Conventional mortgages allow borrowers to take on a mortgage with as little as 3% down. Additionally, USDA and VA loans offer 0% down payment options. These loans will require larger monthly payments, but buyers get 100% of the value of appreciation when they sell. If you can afford the monthly payment, a low down payment loan is a great way to get into a house fast.
Community land trusts: Community land trusts combine permanent affordable housing with the subjective benefits of homeownership. People who buy a home through a community land trust buy the house at a significant financial discount. When it comes time to sell the house, the owner gets to keep some of the appreciation with the remainder gets reinvested in the house to keep the cost of ownership low for the next buyer. “Community land trusts are a permanent affordable housing strategy not a wealth-building strategy,” Selina Mack, executive director of Durham Community Land Trustees explained. “Still, most people who buy into a community land trust ultimately gain enough equity, so they can put a down payment on their next home.”
Limited-equity cooperatives: Limited-equity cooperatives are another ownership structure that combines housing affordability with some of the benefits of ownership. In a limited-equity cooperative, eligible members purchase shares of a building at below-market prices. The shares also entitle them to a long-term lease. When shareholders resell their units, they are limited to a certain percentage of the profit of the sale. Most of the time, limited-equity cooperatives are formed by low-income people who co-own an apartment or condominium building.
Co-buying a property: Buying a property with a family member or a friend allows you to pool resources for a down payment, and qualify for a better loan based on your combined incomes. This method for buying a property gives many of the advantages of a shared-equity mortgage, but you may have to share your living space.
Is a shared-equity mortgage right for you?
People choose shared-equity mortgages for many reasons. For some, it’s the only way to buy a house. Others simply want to enjoy the financial flexibility of a low monthly housing payment. Shared-equity mortgages limit the potential for wealth-building, but they also reduce your downside risk and lower your monthly payment.
When you understand the shared-equity model, you can decide if it makes sense for your personal situation.