Shared-Equity Mortgage Offers Alternative to Down Payments
Struggling to come up with enough of a down payment to buy a home? A relatively uncommon mortgage type known as a shared-equity mortgage might be the solution.
Just be aware that these loans, in which family members provide down payment help in return for a portion of the profits when owners sell their homes, do come with potential pitfalls.
How they work
In a shared-equity mortgage, family members, usually parents, pay a portion of the down payment required for a mortgage. They are then promised a percentage of the profits that the buyers receive when they sell the home. What this percentage is will vary depending on the arrangement to which all the family members agree.
In such loans, parents or family members become co-investors in a home. This means they could lose money: There might not be any profits if a home loses value over time. But they could also make a significant amount of money, too, if a home's value rises steadily.
And at the same time, these co-investors are helping their family members -- whether they be their sons, daughters, brothers or parents -- get into a home.
Sahil Gupta, co-founder of Patch Homes in San Francisco, is familiar with shared-equity mortgages. His company offers its own shared-equity mortgage product, providing mortgage financing at 0 percent interest with no monthly payments. In exchange, Patch Homes shares in the future appreciation of the home's value.
This is obviously a different model than what most people think of when taking out a shared-equity loan. Most shared-equity loans involve buyers who are partnering with family members, most often their parents.
Spelling it out
Gupta said that shared-equity mortgages with family members, though, do come with potential pitfalls, especially when buyers enter into them with family members. The key to making these arrangements work is to craft written agreements, that all the parties sign, that clearly spell out how much of a percentage of the home's future appreciation will be shared, how long the equity-share agreement will last, how much money everyone will contribute to the home's purchase price and when family members will be paid back.
"Negotiating terms with family members can be an awkward situation, but it's important that everyone does it upfront," Gupta said.
Listing when family members will be paid back is especially important, Gupta said. Homeowners need to understand that they will need to pay back the investments made by their family members eventually.
How will they do this? Some owners will state that they will sell the home by a certain date and then use the proceeds of that sale to pay back family members. Others might decide to refinance their mortgage after a certain number of years pass and use the proceeds from that move to pay back their family members.
"Having a plan for paying back family members is helpful," Gupta said.
A written plan should state, too, what happens if the owners of the home default on their mortgage payments, Gupta said. Will the family members that helped them buy the home take ownership of the property, if they can afford to, or will they lose their investment?
Not all lenders say that shared-equity loans are a good idea. Some say that the risks -- of family members losing money or of these same relatives damaging their relationships if owners do stop paying their mortgage bills on time -- of these loans are too high.
They say that buyers struggling to qualify for a conventional mortgage explore programs such as FHA loans or first-time buyer programs offered by their states.
For example, those participating in a shared-equity mortgage need to be aware that housing prices are not guaranteed to rise. A home could lose value. If that happens, the family members participating in a shared-equity loan could lose on their investment.
Before entering such an agreement, then, these family members need to realize that profiting from a shared-equity mortgage is not a guarantee.
"It's always important to know what happens if prices fall and all of a sudden shared equity means everyone is participating in shared negative equity," said Aaron Norris, vice president of Riverside, California-based lender The Norris Group. "Before I would ever consider a shared-equity arrangement with family, I would exhaust all other avenues, including first-time buyer programs at the county and city levels."
There are other options parents and family members can turn to help their relatives or children take out a mortgage.
Ryan O'Kane, mortgage loan officer and principal with ARBOR Financial Group in Santa Ana, California, said that parents, for instance, can gift their children part of or all of their down payment funds. Parents just have to agree, and sign a letter stating, that the funds are gifts and not loans, O'Kane said.
"The benefit of the gift option for the donor or parent is that they are in no way tied to the loan," O'Kane said. "The loan is just in the child's name, so the donor will have no adverse credit issues if the child misses a payment or defaults on the loan."
Parents or relatives can also co-sign on a mortgage loan for their relatives or children. This comes with some potential dangers, though, because co-signers are equally responsible for any loan on which they put their names. This loan will now show up on parents' credit reports, something that will impact them should they decide to apply for any new loans of their own.
Suzanne Weathers, a licensed tax professional and president of Spokane, Washington-based Weathers & Associates, said that buyers should consider the tax benefits of buying a home, too, before they enter into a shared-equity mortgage.
Homeowners can deduct the interest they pay on their mortgage loans each year when filing their taxes. They can also deduct the property taxes they pay.
But what happens in a shared-equity mortgage? Weathers said that all the parties entering such agreements need to discuss who takes the deductions or whether the financial benefits of the deductions will be allocated equally or on a percentage basis to those sharing the mortgage.
"It is my recommendation that you have a discussion with your tax professional as to which would be the most beneficial scenario for all parties involved before the final decision is made," Weathers said. "Whichever decision is made, it should be consistently applied going forward, and reviewed periodically."