What is a Shared Equity Mortgage?
A shared equity mortgage is when a homeowner, who lives in the home, agrees to share ownership of their home with an investor who contributes toward the down payment. In this arrangement, the homebuyer can take out a smaller mortgage loan because they’ve agreed to sell a percentage of their property — as well as any future gains — to the investor.
Shared equity mortgage agreements are usually offered as a form of down payment assistance, but can also make it easier for any buyer to afford a more expensive home. In some cases, they can help existing homeowners convert some of their home equity into a large amount of cash.
How a shared equity mortgage works
A shared equity agreement operates in the background of a traditional mortgage. Just like with any home loan, a borrower takes out a primary mortgage and makes a down payment. The difference is that an investor also contributes a lump sum toward the home’s purchase price. In return, the investor will share in any profits from the home’s appreciation over time. This shared equity arrangement achieves the following:
→ Allows the buyer to make a smaller down payment
→ Allows the buyer to take out a much smaller loan
→ Helps the buyer afford more house for the same monthly payment
→ Gives the investor an ownership stake in the property
The borrower won’t have to make any payments — not even interest — on the lump sum borrowed from the investor until they either sell or refinance the home. At that time, the borrower must repay the investor’s lump-sum amount in full. If the property’s value has increased since purchasing the house, the borrower typically also pays a percentage of that value increase to the investor.
The homeowner will have to make PITI payments on their primary mortgage, but they’ll be more affordable than they would’ve been without a shared equity mortgage in play.
Plus, when a shared equity agreement allows a borrower to make at least a 20% down payment on a conventional loan, borrowers can avoid thousands of dollars in private mortgage insurance (PMI) fees.
Types of home equity sharing
There are actually two types of shared equity agreements that cater to different needs:
- Home equity sharing agreements that allow you to buy a house. These are for borrowers who need help covering their down payment. Today, both private investors and municipal governments use the real estate equity sharing model to offer down payment assistance to qualified buyers.
- Shared equity agreements that allow you to tap your home equity. These may be called shared equity finance agreements or home equity investment loans. They cater to borrowers who want to tap their home equity, but don’t meet the requirements for a home equity loan or home equity line of credit (HELOC).
Most shared equity agreements require borrowers to give the investor a stake in the home that’s equal to that investor’s contribution. For example, let’s say that a city’s shared equity mortgage program pays $20,000 toward John’s $200,000 home purchase. John himself puts down $20,000 and takes out a mortgage for the remaining $160,000. Since the city’s contribution is 10% of the home’s purchase price, the city will hold a 10% stake in any future appreciation.If John later sells the home for $300,000, which represents $100,000 of appreciation, the city would get 10% of that ($10,000). John would also have to repay the city’s original $20,000 investment.
Private investment companies may charge more
Private investment companies may not be as generous with their requirements as municipal programs. They may require a higher percentage of appreciation return compared to the amount they invested toward the purchase. For instance, a shared equity company could contribute $20,000 toward a $200,000 home (10%) but require 20% of the appreciation when the home is later refinanced or sold.
Qualifying for a shared equity mortgage
Many shared equity mortgage programs are offered by city or regional governments as a way to make homeownership affordable for lower- and median-income earners. They tend to come with income limits, as well as residency and property location requirements.
Private shared equity companies 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.
Applying for a shared equity mortgage
When applying for a shared equity mortgage program, 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 homebuyer education course. This is common for programs designed to help put homeownership in reach for underserved populations.
Shared equity mortgage pros and cons
| Pros | Cons |
|---|---|
Increased buying power. With a shared equity mortgage, borrowers can afford to buy a more expensive property without raising their monthly payment costs. Better interest rates. Borrowers with larger down payments can access better interest rates on their primary home loan. Potentially eliminate PMI. With an investor's contribution increasing your down payment amount, you have a better chance of avoiding PMI, saving you hundreds of dollars each year. Mitigated risk. If home prices fall and your home loses value, the investor would share in the loss. You could actually owe the investor less than you borrowed. Reduced monthly PITI payments. Shared equity agreements don't require a monthly payment themselves. However, by using these funds to make a larger down payment, borrowers can reduce their monthly mortgage payments. | Potentially high costs. Depending on your home's future appreciation, a shared equity agreement could easily cost you tens of thousands of dollars when you refinance or sell the home. Limited eligibility. Shared equity mortgage programs are often only offered to residents in certain areas who meet specific income requirements. Reduced wealth-building potential. By sharing your home's appreciation with an outside investor, you limit your total financial gains from the property. If you can't offset this loss through savings or other investments, it may seriously impact your ability to build wealth. Fewer options. There are far fewer shared equity mortgage programs than there are traditional mortgage programs, which can make it more difficult to shop around for the best rates and terms. |
Alternatives to a shared equity mortgage
Low-down-payment loans
Conventional loans allow borrowers to take on a mortgage with as little as 3% down. In addition, FHA loans, VA loans and USDA loans offer 0% to 3.5% down payment options to qualified buyers.
These loans will require larger monthly payments, but buyers get to keep up to 100% of their home’s appreciated value when they sell. If you can afford the monthly payment, a low-down-payment loan is a great way to get into a house, and it comes with fewer costs down the road.
Community land trusts
People who buy a home through a community land trust get to buy the house at a significant financial discount. When it comes time to sell, the owner gets to keep some of the appreciation while the remainder is reinvested in the house to keep the cost of ownership low for the next buyer.
Limited-equity cooperatives
Most of the time, limited-equity cooperatives are formed by low-income individuals who co-own an apartment or condominium building. Eligible members purchase partial ownership of a building, known as “shares,” at below-market prices. Their shares also entitle them to live in the building under a long-term lease.
When shareholders resell their units, they are limited to a certain percentage of the sale proceeds.
Co-buying a property
Buying a property with a relative or 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.
Co-buying a property provides many of the advantages of a shared-equity mortgage, but with one big caveat: You may have to share your living space. On top of that, if you later want to remove one buyer from the mortgage, it isn’t always as simple as you might hope.
Borrow a down payment
Consider asking a parent or another close relative to lend you money for a down payment. If they’re open to the idea, it’s smart to draw up a strong agreement for repaying the funds (including any interest), and ensure that both parties feel secure with the arrangement. Just keep in mind that the loan will factor into your DTI ratio when you apply for a mortgage, since it’s additional debt.
However, many lenders will require your down payment funds to be “seasoned” — that is, it needs to have been in your possession for at least two months. If so, you’ll need to take that into account and arrange to borrow the money well in advance of your mortgage application.