Is a Shared Equity Mortgage a Good Idea?
In these times of rising mortgage rates, home buyers are looking for every advantage to help them get the financing they need to buy the home they want. First-time buyers, who don’t want to put down the traditional 20 percent, have many options to get a lower down payment. In fact, low down payment programs are so popular today that first-time buyers typically put down only five percent, far less than the average 14 percent down payment by repeat buyers.
The Federal Housing Administration’s (FHA) program is the most popular. FHA insures loans at 3.5 percent from approved lenders. Both Fannie Mae and Freddie Mac offer three percent down loans to first-time buyers who qualify. Many private lenders also offer low down payment options that range from zero to 10 percent of the purchase price. State and local housing agencies, non-profit organizations, and some employers also provide low down payment assistance to qualified borrowers. To find out more about the 2,500 state, local, non-profit, and employer-sponsored down payment assistance programs available today, check out Down Payment Resource. These programs are so popular that in 2017, first-time buyers put down a median of only five percent.
Most down payment assistance options require borrowers to take out mortgage insurance, which adds to the monthly cost of owning a home. One option that avoids the requirement for mortgage insurance is “shared equity.”
How Shared Equity Works
Equity, is the “profit” you make from owning your home. It’s the difference between the value of your home and the remaining principal that you owe on your mortgage. If you owe $100,000 on a home worth $130,000, you have $30,000 in equity. Equity grows when the value of your home appreciates and when you reduce what you owe on your mortgage as mortgage principal. Owners who participate in equity sharing plans remain in complete control of their property.
Some 33 shared equity programs are offered by state and local housing finance agencies. They help to keep the home prices affordable for the next buyer and continuously re-fund the program. Benefits to the buyer include helping lower their first mortgage, thereby reducing their monthly payments, and accruing more equity from paying down the mortgage faster.
Private investment companies also offer shared equity plans to buyers. Investors provide a down payment large enough to total 20 percent or more of the mortgage when matched with a borrower’s down payment. When you sell or refinance, you must buy back the shared equity, which includes the investor’s original investment, plus a percentage of the gain (or loss) of your home’s equity.
Investor Shared Equity Programs
Unlike plans from local and state housing finance agencies, private shared equity programs are not limited to moderate-to-low income owners. The best known shared equity plans for home buyers and homeowners are offered by Unison and is now available in 22 states. Unison typically provides half of the down payment funds that a buyer will need. There are no restrictions on how a homeowner can use these funds. Unison requires its customers to buy back their equity share at the time of sale when refinancing or 30 years, whichever comes first.
So if your home loses value instead of gaining, does the investor shares in the loss? If an investor provides $10,000 for a down payment on a $100,000 home and it sells for only $90,000, it has lost 10 percent of its value and the investor is repaid only 90 percent of his investment, or $9,000.
Is a shared equity down payment a good option for you?
Shared equity arrangements are perfect for many homeowners or buyers. They help owners avoid mortgage insurance and can be used for more than down payments. Yet, they may not be right for everyone. Here are some pros and cons to consider before you sign up.
- Shared equity avoids the costs of mortgage insurance.
- With shared equity, you can increase the size of your down payment. A lower down payment will lower the size of your monthly payments and make it possible to access a better mortgage interest rate.
- Unlike a loan, shared equity doesn’t involve lenders fees, mortgage interest, settlement fees, and other closing costs. Many investors also require an appraisal.
- Shared equity helps a buyer avoid losing a home to a low appraisal if he can obtain a larger investment to increase the size of the down payment.
- Shared equity increases your buying and makes it possible for a buyer to spend more than the initially pre-approved amount.
- Shared equity reduces the profit you would otherwise make from your equity.
- Shared equity discourages buyers from prepaying their mortgage.
- Shared equity can tempt buyers to buy more than they can really afford, and they might become vulnerable to default if they have no cushion of equity should home values drop.
- To get credit for improvement, you must order an appraisal. Most likely, the appraised value will not reflect the total amount you spent on the project.
- With just a few housing agencies and private lenders offering shared risk loans, you don’t have a wide choice of options today.
- If your property appreciates substantially, you could end up paying the investor more in a shared equity agreement than what a conventional mortgage with private mortgage insurance would have cost.
- Not all mortgage lenders will work with a shared equity arrangement, which could limit your choice of lenders.
Before proceeding with a shared equity deal, review all your other options. Be sure to do your due diligence with any shared equity partner. Check them out with your state regulator and ask your Realtor for advice.