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What is a Shared Equity Mortgage?

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A shared equity mortgage is a financial agreement in which a financial institution acts as both the lender for and an investor in a property. In this arrangement, the homebuyer agrees to sell a percentage — as well as future gains — of their property to the lender in exchange for a smaller mortgage loan.

Shared equity mortgages can make it easier for buyers to afford more expensive homes, and may even provide down payment assistance if needed. Here’s everything you need to know.

How a shared equity mortgage works

In a traditional home loan, buyers contribute an upfront share of the cost (known as a down payment) while the bank lends the remaining amount in the form of a mortgage loan. Shared equity mortgages, however, work a bit differently.

THINGS YOU SHOULD KNOW

Today, many private investors and municipal governments use the real estate equity sharing model to offer down payment assistance to qualified buyers. Borrowers can take the proceeds from a shared equity mortgage and use them to make a (larger) down payment with their mortgage lender. This can reduce the monthly mortgage payment amount and, in some cases, may even enable borrowers to avoid costly fees like private mortgage insurance (PMI).

Borrowers aren’t required to make payments on their shared equity mortgage loan until they either sell or refinance the home. At that time, the borrower will repay the principal value of the shared equity home loan, along with a percentage of the property’s increased value (appreciation), if applicable.

Example of a shared equity mortgage

The exact terms of a shared equity mortgage agreement will vary from one lender to the next — though there aren’t many U.S.-based shared equity lenders who offer this product in the first place.

Most publicly funded shared equity loans will require borrowers to split any appreciation of the property, proportionate to the city’s original contribution toward its sale price. So, say that the city offers a $20,000 loan on a $200,000 home; since that loan equates to 10% of the home’s purchase price, the city will hold a 10% stake in any future appreciation.

Original home purchase ($200,000) Future home sale 
Home value $200,000 $300,000 (appreciation of $100,000)
Buyer $20,000 contribution $110,000 walk-away ($300,000 sale amount – $30,000 paid to shared equity lender – $160,000 principal loan)
Shared equity lender $20,000 contribution (10%) $20,000 principal loan + $10,000 (10% of appreciation) = $30,000 total payment
Mortgage lender $160,000 remaining balance $160,000 principal loan*

*not accounting for amortized interest

Private investment lenders may not be as generous, however, and may require a higher percentage of appreciation return than what they offered toward the purchase. For instance, a shared equity lender could contribute $20,000 toward a $200,000 home (10%) but require 20% of the appreciation when the home is later sold.

Qualifying for a shared equity mortgage

The exact process of applying and qualifying for a shared equity mortgage will depend on the program or individual lender you choose.

Private shared equity lenders may have more flexible requirements, allowing borrowers of all incomes to receive down payment assistance in exchange for a share of the property’s future appreciation.

However, 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. This means that many shared equity mortgages are limited to middle- or lower-income borrowers who meet certain need-based standards.

For example, San Francisco’s Downpayment Loan Assistance Program (DALP) is only available to first-time homebuyers — meaning that they haven’t owned a home anywhere in the last three years. Borrowers must also meet household income requirements based on size: For a one-person household, the maximum income is $163,200, while a six-person household could make up to $326,400.

The San Francisco DALP is also lottery-based. Even if you qualify, applications are processed according to lottery order, which may not guarantee that you’ll receive funds in a specific period of time.

In Austin, the Homebuyer Down Payment Assistance Program offers up to $40,000 as a silent second loan, intended to help with down payment costs. Eligibility is limited to those buying a home with an appraisal value of $295,000 or lower. Household income can’t exceed 80% of the area’s median income, with a maximum income of $85,450 (for a five-person family).

When applying for a shared equity mortgage loan, you should expect to provide a combination of the following:

  • Proof of income (including W-2 or 1099 forms, previous tax returns and pay stubs)
  • Recent bank statements
  • Verification of other assets
  • Various forms of identification (Social Security card, photo ID, state driver’s license, passport)

You may also be asked to take a homeowner’s education course. If applying for a locality-based loan, you’ll also need to meet any residency and property location requirements.

Pros and cons of a shared equity mortgage

Before taking out a shared equity mortgage, there are a few benefits, as well as downsides, to consider.

Pros

  They increase your buying power. With a shared equity mortgage, homebuyers can afford to buy a more expensive property without raising their monthly payment costs. This can be especially important for lower-income buyers who may be struggling to afford homeownership, or are unable to save as large of a down payment.

  They may unlock better interest rates. Borrowers with larger down payments may be able to access prime interest rates on their home loan. With a shared equity loan acting as a silent second mortgage, this can be easier to achieve.

  They enable borrowers to eliminate PMI. Private mortgage insurance (PMI) is a monthly fee that borrowers have to pay if they put down less than 20% toward their home purchase. This is often due to a smaller down payment or buying a home above market value. With a shared equity loan increasing your down payment amount, you have a better chance of avoiding this fee, saving you hundreds (if not thousands) of dollars each year.

  They reduce downside risk. If home prices fall in a weak real estate market and your home loses value, your shared equity loan may turn out to be a better deal. In this case, your lender would share in the loss, and you’d actually owe your lender less than you borrowed.

  They may reduce your monthly mortgage payment. Shared equity loans don’t require a monthly payment themselves. However, by using these funds to make a larger down payment, borrowers can reduce their overall mortgage loan amount and shrink their monthly payments.

Cons

  They may limit your wealth-building potential. By sharing your home’s appreciation with an outside investor/lender, you limit your total financial gains from the property. If you can’t offset this loss through savings or outside investments, it may seriously impact your ability to build wealth.

  They could cost more than a conventional mortgage. It’s imperative that you crunch the numbers before choosing a shared equity mortgage for your next home purchase. Lower down payments could result in higher interest rates, PMI and other added costs, but depending on your home’s future appreciation, a shared equity loan could easily cost you tens of thousands of dollars when you sell or transfer the home. Which is the better deal? You’ll need to consider this before taking on a shared equity loan.

  They limit your eligibility. The best shared equity loan programs are offered by cities and municipal governments, rather than the private sector. They are generally only offered to residents in certain areas who meet certain income requirements, which may limit your access to them if you’re buying in a certain area or make too much money.

  They don’t come with many options. Very few companies work in the shared equity mortgage space, so it can be tough to know whether you’re actually getting a competitive offer. Since you can’t compare many options, you’re often left to “take it or leave it,” making it hard to determine whether it’s truly your best option.

  They can be very expensive in a good housing market. If home prices rise drastically (as we’ve seen in recent years), a shared equity mortgage loan may wind up costing you a lot more than you had anticipated. Sure, you’ll still enjoy some of that upside benefit, but a notable share will go toward your lender, reducing your takeaway from the increased value.

Alternatives to a shared equity mortgage

If you decide that a shared equity loan isn’t the best fit, or simply want to see what other options are available to you that still keep homeownership affordable, here are some alternatives to consider.

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 to qualified buyers.

These loans will require larger monthly payments, but buyers get to keep 100% of the value of their home’s 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 while 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,” explained Selina Mack, executive director of Durham Community Land Trustees. “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 sale proceeds. Most of the time, limited-equity cooperatives are formed by low-income individuals 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 your resources for a down payment. Doing so may help you qualify for a better loan based on your combined incomes and assets. And if desired, you can always remove one buyer from the mortgage down the line.

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. It may also come with added risks: For example, consider what you’d do if one of you is suddenly unable to contribute to the monthly mortgage payment, or winds up in debt with other creditors.

Borrow a down payment: If you have a parent or another close relative with the means to lend you money for a down payment, consider asking. You should draw up a strong agreement for repaying the funds (including any interest), and ensure that both parties feel secure with the arrangement.

Note too that some lenders will require your down payment funds to be seasoned, so this loan may need to happen well in advance of your mortgage loan application.

 

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