If you’re struggling to save for a down payment or qualify for a home equity loan, this new home buying option might be right for you. Here, we’ll talk about shared equity contracts, including what they are, how they work, and how they might be of benefit to you as a homeowner or buyer.
What is a Shared Equity Contract?
Sharing a mortgage with someone to whom you aren’t married isn’t unheard of. I have neighbors--two single young adult women--who bought a home together a couple of years ago. It just made more sense to buy in our area rather than rent, and the arrangement seems to be working well.
But sharing a home with an investment company? This is a bit of a newer scenario. But it’s one that’s becoming more common as investing companies seek to capitalize on rising home prices around the country.
A shared equity contract is what allows investors to do this. It lets an investor or investment company put money into your actual home. This gives you, the homeowner or home buyer, access to the investor’s cash. You can use the money for a down payment, or use it similarly to a home equity loan or line of credit. And then the investor makes a profit if your home value increases.
You don’t have to pay back the money monthly, but you do have to buy out the investor after a certain amount of time. The contract lengths vary but can go up to 30 years. You can repay the contract early, especially if you sell your home before the end of the contract.
The amount you pay back, though, varies. You could pay much more than the original investment amount if your home’s value increases. Or you could pay less than the original amount if your home’s value decreases.
Basically, a shared equity contract lets you access cash for a down payment or home equity loan without taking on actual debt. And since it’s not technically a debt, it may be easier to qualify, income and credit-wise.
It’s easier to see how these arrangements work with an actual scenario, so let’s look at that now.
How It Works: Scenarios
The shared equity agreement lets the investor tap into your home’s equity if it grows. They’ll take a loss if the value of your home decreases. So it’s important to understand how this scenario might play out for you.
Using this scenario calculator from Unison, one of the companies currently offering this option, well look at what might happen with an example scenario.
Here are the details:
Current Home Value: $300,000
Unison Investment: $30,000
Unison Share of Change in Value: 35%
So basically, let’s say you want to buy a $300,000 home. You have $30,000 for your down payment, but to avoid PMI and a higher rate, you need $60,000. So Unison invests $30,000 in your home. You agree to buy Unison back out of the home within 15 years.
You wind up with a $240,000 mortgage. If after 15 years the house’s value increases to $400,000, you’ll owe Unison a total of $65,000. That’s the $30,000 they originally invested plus their 35% share of the home’s increased value. If the home loses $100,000 in value, you’ll owe -$5,000. If the home’s value stays the same, you’ll just owe $30,000.
You can see the numbers in the chart below:
One thing to note about these arrangements is that any amount you pay down on your mortgage belongs to you. The investors only have interest in the original amount they give you, plus any increase or decrease in the home’s sale value.
So, really, in all of the scenarios presented above, you’d actually get more gross sale proceeds back in your pocket. After 15 years, you’d have built up significantly more equity just by paying down your mortgage. So you could get quite a bit more money back in your pocket, even if the investor takes a larger cut due to increased home values.
Who is it Right For?
Share equity contracts are typically billed as a way to help people who cannot save up enough for a down payment. And in these situations, they may be the right option.
Say you can’t get enough money together to put 20% down on a home. You will pay more in interest and private mortgage insurance (PMI). So you may benefit from taking money from an investment company, even if you have to pay it back at some point.
Of course, you can also risk losing quite a bit of your home’s appreciated value if the equity rises quickly. In one scenario above, for instance, you could be stuck paying the investor an extra $35,000, on top of what you already owe them.
But even in this case, you wouldn’t owe the investing company all of the increased value of your home. So you could still build equity for your next home purchase while using a shared equity contract.
With all this said, I think there are some times when this type of situation could be particularly useful. Here are a few examples:
If you need a home in a hot market
Some of the examples of happy homeowners offered by investing companies like these are buying in particularly fast-moving markets. Let’s say you take a job in an area where houses sell notoriously quickly. Having a larger cash down payment makes you more attractive as a buyer. This can help you find and settle into a home more quickly.
In this case, you could use cash from a shared equity contract to boost your down payment. Then as soon as you’re able, you can refinance the house or take out a second mortgage to buy out the investing company sooner rather than later. Buying them out sooner mitigates the risk that your house’s value will skyrocket, leaving you owing them a lot more money.
If you’re truly in a hot market with increasing home prices, you may need to pay the investing company a bit more than you originally did. But if you get out of the contract quickly, it’s less likely to be tens of thousands of dollars. And the premium might be worth your while to be able to get into a home that suits your needs.
When increased interest and PMI outweigh the risks
Private mortgage insurance and the increased interest rate that comes with a lower-down-payment mortgage can be expensive. Even if you’re buying in a slower market, consider the costs of these expenses. And then check to see if a shared equity contract could get you out of some of those costs.
As with the scenario above, this assumes you’d use the investment as part of your down payment. If the higher down payment amount significantly reduces your monthly homeownership expenses, it could be worth your while. But you’ll want to keep an eye on your local housing market. If values start to boom, take out a second mortgage to buy out the investor before you wind up owing a lot more money.
If you’re struggling with consumer debt
Rolling high-interest consumer debts into a low-interest HELOC can be a good option for some people. But it’s a bit of a catch-22. If you have lots of consumer debt, you probably don’t have great credit. And this can make it difficult to get a HELOC or second mortgage.
Since shared equity agreements aren’t technically loans, their credit and income requirements are often lower. So you may qualify for a cash payout from an investor. You can then use this money to pay off your consumer debt. And then you’ll likely see your credit score increase--maybe right away.
After a couple of years when you’re allowed to buy out the investor, you can take out a home equity loan or line of credit to buy them out. So it’s a more roundabout way of using a low-interest loan to pay off high-interest debt.
You know you’ll sell before the term is up
These arrangements may be easier to stomach if you know you’ll sell the home before the shared equity contracts term is up. If you know you’ll move in 10 years when your kids go to college, sign an agreement for 15 years.
Sure, you could still lose a share of the increased value of your home over that 10 years. But taking a bite out of your equity during the sale may be easier to stomach than having to take out an interest-bearing loan to buy out the investor.
In this case, you also mitigate some of your personal risk if the value of your home should decrease. In case of decreasing home values, you won’t have to worry about being underwater on a mortgage or a second mortgage so that you cant sell your home when you need to.
Caveats to Understand
Before you jump on board, even if you fit into one of the categories above, here are some things to know about these agreements:
- You don’t get all the equity you give away. The biggest thing to understand is that you’re giving away more equity in your home than you’re getting. Remember our Unison example above? In this example, Unison gives you cash for 10% of your home’s equity upfront--half of your 20% down payment. But they actually get 35% of your home’s increased equity in return. This isn’t necessarily a deal-breaker, but it’s important to understand.
- So there may not be as much money as you’d like. Because of the point above, you may not be able to get as much cash out of your home as you’d like.
- There are fees for originating the not-really-a-loan. These aren’t really loans, of course. But they still carry loan-like fees, including origination fees. Plus, you’ll have to pay for other steps in the process, like an official appraisal of the home.
- You might be penalized for improvements, or you might not. Some companies, like Point, will share in any increases in your property value due to improvements that you make. Others, like Unison, seem to make a good faith effort to factor improvement-related gains out of their equation. So they don’t share in those gains. However, making these adjustments can be tough. So be sure you understand how this works if you plan to make valuable home improvements during the agreement term.
- It’s not available everywhere. Right now, these companies are largely focused on hot housing markets in large cities with growing markets. They also tend to focus on more expensive properties. Some have a bottom limit of $300,000 in housing value. So if you’re outside of these areas, this may not work for you.
- Things get tricky if you can no longer make mortgage payments. Because of the way these agreements are written, the investors should not technically be able to force you to sell your home. But they do share a stake in the home. So if you find yourself unable to make your mortgage payments, they could seriously complicate the process of foreclosure or short sale.
Where to Get Started
If you’re looking to buy a home--or already own one--in a high-value, rapidly-growing market, you may be able to tap a shared equity contract. Several companies are currently offering such arrangements to homeowners and home buyers. Check out Point, Noah, and Unison for more information on their programs.
As with any other lending or investing program, be sure to dig into the particulars. These companies all have different limitations and requirements, as well as different fee structures. Be sure to look around to see which option will work best for you before you decide to try this arrangement.