A shared equity mortgage is an arrangement where someone buying a home receives down payment help from a friend or family member in exchange for equity on the home. This most often happens when a parent is helping a child with the initial payment and can benefit from an increase in the value of the home in later years. With a typical share equity mortgage, the person helping with the down payment typically receives a percentage of the price of the home on resale plus a percentage of the increase in value. The risk from this agreement to the lender arises if the home depreciates in value or the borrower fails to comply with the original agreement.
Many young adults looking to buy a home may not have the capital to pay the down payment needed to secure a fixed-rate mortgage. In contrast, their parents may have the capital to help these potential homeowners. A simple loan does not offer much benefit to the lender, but an equity mortgage does the double duty of helping the child while being an investment for the parent.
As an example of a shared equity mortgage, imagine a young couple looking to buy a home worth $ 250,000 (USD) but only have $ 10,000 of the $ 50,000 that goes for a Fixed rate mortgage are needed. They ask the man’s father for help and he gives them the rest of the down payment, which is $ 40,000. Since that $ 40,000 is 16 percent of the home’s value, the father is given that percentage of the home’s resale value and the same percentage of any resale value added.
So if the house were to appreciate $ 500,000 in value by the time the couple decided to sell, the man’s father would be entitled to 16 percent of the $ 500,000 or $ 80,000 and 16 percent of the profit of $ 250,000 or $ 40,000 USD. That means that on an initial investment of $ 120,000, the father will get a return of $ 40,000. Note that the percentages are not automatically determined by the percentage loaned to the homebuyer and can be set by the parties at a rate that is mutually acceptable.
It is important to understand that there are pitfalls in getting a shared equity mortgage. For example, if the family members rely on trust and do not conclude the agreement in writing, unilateral withdrawal from the agreement is possible. This can cause family hardship, as well as potential financial problems for one or both parties. In addition, if the home is depreciated, the lender may be responsible for the depreciation, depending on the credit terms.
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