The Good And Bad Of Shared Equity Financing
How many people do you know that have taken advantage of financial products such as interest-only mortgages, piggyback loans or option adjustable-rate mortgages in order to *afford* a more expensive home?
Many of these options carry a considerable amount of risk and have been resulting in more people defaulting on their loans when the initial terms of the loan expire and the rates adjust, resulting in a payment that is no longer affordable. Now there seems to be a new option that has been gaining some popularity and that option is shared equity financing.
What is Shared-Equity Financing?
In a shared-equity financing arrangement, you have one or more investors that are contributing funds towards the purchase of a home or property with the payback being a percentage of any appreciation in the property. In many cases, the investors will be the parents of the purchaser but the possibility exists to have 3rd party investors as well.
There aren’t any clear cut guidelines to how these deals are arranged and they can be negotiated between the parties to determine things such as who is responsible for the property taxes and who receives the tax deduction for mortgage interest. While these arrangements are fairly informal and flexible, it is still advisable to have a written contract explaining all of the details that have been agreed upon.
Benefits of Shared-Equity Financing
From the perspective of the purchaser, the largest benefit is that a shared-equity arrangement will allow them to buy a more expensive home than they may qualify under normal circumstances. Depending on the market, it can be rather difficult to afford a home large enough for a growing family and this allows the purchaser to live in a nicer neighborhood and/or home than might otherwise be possible.
As the investor in a shared-equity arrangement, you gain the opportunity to participate in the real estate market and property appreciation without having to go out and purchase or maintain a property. Rather than dealing with rental properties and being a landlord, you can invest a set amount of money and then receive a percentage of the future appreciation. In many cases, the shared-equity arrangement include an end-date that specifies when the investor will get their money either through the sale of the property or a refinancing.
Negatives of Shared-Equity Financing
Too many times people attempt to buy a home that they truly cannot afford and this type of financing arrangement has the potential to contribute to that problem. When a homeowner stretches themselves to afford the monthly payments, any unexpected problems such as a broken water heater or furnace can derail their financial situation.
Given that many shared-equity arrangements are taking place between parents and their adult children, you run the risk of family tension should any problems arise. What happens if the new homeowners neglect the property and the house depreciates in value? Will the parents resent the children for their actions that may have cost them money? Will the parents want to intervene in decisions given that their money is on the line?
As the investor, I don’t think this is a viable solution unless you are already financially independent and very secure. If the funds would have to come from your retirement savings or otherwise put you at risk, this is probably not the wisest decision for you. While it doesn’t happen very often, real estate can depreciate in value and there are no guarantees that you will see any financial gain from your investment in a property. You should only be willing to invest money that you are willing to lose.
Verdict on Shared-Equity Financing
While I do see some benefit to a shared-equity financing arrangement, I do not think it is the right choice for most people. There is the potential for a win-win situation for the purchaser and investor if everything is carefully arranged and well detailed.
However, in my opinion, the potential risks involved outweigh the gains and I would encourage people to stay within their means and buy a home that is affordable for their situation. Personally, this is not something that I would ever ask of my parents nor would I entertain for my own children.
If you would like to read more about shared-equity financing, check out the Parents Backed Mortgage article over at Yahoo! Finance.