Homeownership has its own piece of the sharing economy. For many years, nonprofit players have offered loans to borrowers in exchange for a share of the equity that accumulates in the borrower’s home. Recently, for-profit investors have sought to enter this shared economy, a move that could expand and spread the benefits of this idea. But is this always a good deal for buyers?
Introducing shared equity
As the homeownership rate continues to fall and mortgage credit remains tight, many aspiring first-time homebuyers are stuck in a bind. In hot markets, rising rents and house prices make saving for a down payment difficult. In cooler markets, stagnant wages and competition from cash buyers make it hard to buy a home without a substantial down payment.
This dilemma has increased interest in “shared equity” homeownership models that fall between owning and renting. In a shared equity transaction, a third party helps homeowners purchase a house in return for a share of any appreciation in its value. This reduces the amount of money the buyer must bring to the transaction for a down payment and lowers monthly mortgage payments.
Mission-based or publicly subsidized shared equity programs like community land trusts, deed restrictions, and limited equity co-ops have existed for many years and have helped thousands of families become homeowners and sustain homeownership. But the programs, which depend on scarce public subsidies, have not achieved significant scale.
Enter private investors
Over the past six months, a half-dozen entrepreneurs have stepped in to take shared equity to scale. Will these efforts be advantageous to consumers?
Some capital markets efforts are aimed at debt consolidation and other strategies that enable homeowners to trade a portion of their home’s equity for lower-cost financing. But more recently, we have seen efforts aimed at enabling potential first-time homeowners who either lack a sufficient down payment or have insufficient income to support a debt-to-income ratio on the home they want to purchase.
These new first-time homebuyer approaches (e.g., Unison and Own Home Finance) use funds from private investors to pay enough of the purchase price to bring the loan-to-value ratio on the first mortgage under 80 percent and avoid the cost of private mortgage insurance. In addition to a smaller down payment requirement, the smaller mortgage and the lack of private mortgage insurance mean the monthly mortgage payment is less than the borrower likely would have paid without sharing the equity.
In return, the investor receives a share of the home’s appreciation once the home is sold or the relationship is terminated. How big a share and how it is characterized varies.
Questions to ask before sharing
Are these and similar approaches the right move for buyers? Potential homeowners should ask several questions before agreeing to any home equity product:
- How well are the features of the shared equity approach explained? Are potential homeowners sufficiently educated about the terms of equity sharing and homeownership?
- Who is eligible to participate in these models, in terms of assets, income, credit score, and cost of the home?
- What is the all-in cost of participation, including up-front fees, servicing fees, and third-party fees?
- How does the interest rate and all-in interest cost over time differ from what would be available from the Federal Housing Administration or government-sponsored enterprises?
- How long does the equity sharing last? If it ends before the buyer wants to sell, how are the investors repaid?
- How can a borrower terminate the shared equity relationship, and how is the home’s value at termination determined, especially if the borrower wants to end the relationship without selling the home?
- Are there restrictions on the borrower’s ability to, for example, obtain a home equity line of credit?
- How are capital improvements fully paid by the homeowner taken into account in determining the investor’s share? How is deferred maintenance dealt with?
- What happens to the shared equity relationship if a borrower defaults on the first mortgage or fails to pay property taxes?
- What consumer protections will apply to the relationship between the homeowner and the investor? Must disputes be settled by arbitration?
- How good a deal are these models under various conditions, such as home price appreciation or depreciation, whether the borrower uses this approach to buy more house or to save money, and how long the borrower lives in the home?
Shared equity that works for first-time homebuyers is intriguing and likely to happen at scale only if the capital markets become significant participants. But because this is a new model, consumers need to be vigilant about protecting their interests and ensuring they understand all the transaction’s implications before signing away any ownership.
As researchers focused on accruing evidence about policy approaches to expanding homeownership to all who can benefit from it, we’ll be watching these programs’ development.