Rising mortgage rates and higher prices are likely to bring an increase in a concept known as equity sharing, especially for first-time buyers who are short on money for the down payment and closing costs.
Equity sharing works like this: In exchange for a slice of the value you build up over the years, a third party will spot you the cash you need to make the deal work.
The scheme has been around for years. Mission-based or publicly subsidized equity-share programs, such as community land trusts and limited equity co-ops, have helped thousands of families become homeowners.
Now, a dozen or more for-profit investors have entered the market or are about to, expanding the sector exponentially. But the various programs are not created equal. Rather, they’re all over the ballpark in their terms and conditions.
Consequently, “consumers need to be vigilant about protecting their interests,” says the Urban Institute’s Housing Finance Policy Center, an independent think tank examining the issue.
This is a “fast moving” concept, as at least 12 firms are “still in the launching stage and shopping for both customers and investors,” says Brett Theodos, a senior research associate at the policy center. That is, firms are seeking customers to borrow the money and investors to provide it.
The center is focusing its research around a number of questions, according to Theodos. And they are the same ones would-be clients should be asking to determine if equity sharing is right for them, and if so, which company’s program best fits their needs.
Here are the major variables to consider:
-- Charges: What is the all-in cost of participation, including up-front fees, servicing fees and third-party fees? Generally, they should be in line with what regular lenders are charging. Ask to see a complete list.
-- Terms: How long does the program last? Typically, they run for seven or 10 years, which is within the time frame in which most people sell and move on. But what if it ends before you are ready to sell?
You’ll probably be able to refinance, pay off your equity partner and have enough left over for a healthy down payment on your next place. But what if values have remained flat during your tenure as an owner? Or worse, what if values have gone down? Does your equity partner share in the downside as well as the upside? And if so, what portion of the loss does the firm cover?
-- Value: How will the value of your property be determined? By an appraiser, or an automated program? If it’s an appraiser, will he be hired by your partner or by you? And who determines the accuracy of the valuation? Also, who pays for it?
-- Termination: What happens if you want to end the pact early, before its term is up? Is there a penalty?
Say, for example, that you have a 10-year agreement with your equity partner, but you want to sell and move elsewhere sooner. Investors are expecting a certain return on their money, and by moving, you are cutting into their return on investment -- perhaps drastically. How exactly is this situation handled? And make sure the answer is in writing as part of your deal.
-- Restrictions: Can you obtain a home equity line of credit or a second mortgage based on the increased value of your property? If you are spending your equity for whatever reason -- perhaps a European vacation or remodeling project that will add value -- your partner will want to have a say. So, what are the rules?
-- Improvements: Are you allowed to make capital improvements such as an addition or finished basement? How are they taken into account in determining the investor’s share? If you pay for improvements entirely, do you get all of the extra value attributable to the improvements, or does your partner get to share in that, too?
-- Default: What happens if you don’t pay your property taxes, or can’t make your house payments and default on your loan? Again, ask to see the rules. A number of seniors who took out home equity conversion mortgages -- aka reverse mortgages -- lost their houses because they either didn’t realize they still had to pay their taxes and keep their homeowners’ insurance up to date, or just failed to do so.
-- Disputes: How will disagreements be settled? Will you be required to take your beef to arbitration or can you go to court? If it’s arbitration, who gets to choose the arbiter -- you or your partner?
Make sure you thoroughly discuss all of these issues before committing to any equity-sharing plan.