What Is a Shared Equity Mortgage? Top Pros and Cons
Buying a home is a huge financial decision. Purchasing one requires large sums of money. You also need to consider down payments and other upfront costs.
Not everybody can pay for all these themselves. You can spend tens of thousands of dollars on down payments alone.
This is where financing programs like shared equity mortgages come in. But what exactly is it?
What is a shared equity mortgage and how does it work?
Shared equity mortgages are loans covering a percentage of the upfront costs of buying real estate. You can get this loan from non-profit organizations, local governments, or the private sector.
The terms and conditions of the loan depend on the lender. Some require you to live in the home for a number of years before you can sell it. Others would implement a cap on how much you could sell the property for in the future.
This is done to ensure real estate prices in certain areas remain reasonable. It also helps low to minimum-wage earners secure homes.
Another term used for shared equity mortgages is “partnership mortgage”. Loan providers can act like a “silent partner” in your purchase. This should not be mistaken for home co-ownership or fractional ownership.
Even if it’s a “shared mortgage”, it doesn’t mean you share it with someone else. The home you buy will belong to you.
Instead, lenders can get a percentage share of the appreciated price when the property is sold. This percentage could be higher when loaning from private investors.
Here are some examples:
Shared Equity Mortgage Examples
One of the advantages of shared equity mortgages is that a loaner doesn’t have to pay the loan until they refinance the home or sell it.
Let’s use this scenario as an example:
The total cost of the property is $300,000. You get a publicly funded shared equity mortgage worth $30,000. This equates to a 10% loan of the total price. The lender now has a 10% stake in future appreciation when the property is sold.
Here is another scenario using an example from a financing program in Austin called the Homebuyer Down Payment Assistance program. Residents can avail of a $40,000 silent second loan to secure down payments on a property.
But the loan is limited to people buying a home with an appraisal value of less than or equal to $295,000. In addition, only residents within a certain wage bracket can avail of the loan.
For this specific program, the household income needs to be less than 80% of Austin’s median income. The yearly income should also fall below $85,450 for a family of five.
Shared Equity Mortgage: Pros and Cons
There are several advantages to availing partnership mortgage. But before applying for a loan, you need to weigh both pros and cons.
Pros
More Accessible - Low-income earners gain access to affordable homes with the help of this loan. It can cover a large percentage of down payments and closing costs.
Lowers Local Housing Rates - The benefits can also be seen beyond an individual level. Local housing rates in certain areas are moderated thanks to loan restrictions. This prevents people from selling homes at obscene prices.
Builds Finances - From a financial aspect, the loan also helps build your equity and saves you from costs related to Private Mortgage Insurance (PMI).
Lowers Risks - This loan reduces the risks associated with buying property. If housing prices fall due to a weak real estate or short-term rental market, lenders also share your losses. You can then owe less than your initial loan.
Cons
Lesser Profits - Homeowners get lesser profits because of selling caps or shared property appreciation. If you can’t find ways to offset these losses it could hinder your capability to grow your wealth.
Higher Interest Rates - Having lower down payments because of the loan can also lead to higher interest rates, PMI, and other costs. Be sure to do your research and calculations before applying for a loan.
Limited Options - Your options are limited with shared equity mortgages. Not a lot of companies offer this type of service. This can force you into a “take it or leave it” situation.
The loan is also offered to a select few that meet specific requirements. This makes it rare and hard to secure. So instead of buying a property outright, some invest in Real Estate Investment Trusts (REITs).
Difficult to secure - Local governments are also the best place to find such financial assistance programs. That means the offer is limited to the residents of those areas covered by cities or municipalities. If you make too much money, you may not even fit the criteria for a loan.
Should You Get a Shared Equity Mortgage?
If you’re planning on buying a home with the assistance of loans from shared equity mortgages, answer the following questions:
- Are you buying a home for the first time?
- Do you lack the down payment for closing costs for the home?
- Have you considered the long-term costs associated with it?
- Do you fit the criteria for the financial assistance program?
- Are you willing to let go of a certain percentage of future appreciation?
If the answer to those is yes, then getting the loan may be a sound idea. There are workarounds to the cons and it can benefit communities altogether.
Key Takeaways
Shared equity mortgages provide better opportunities for low-income earners to secure homes for their families. It improves finances by building equity and allows easy access to cash, and funding for home projects, and can even help with retirement.
There are definitely a lot of upsides when it comes to this type of loan. But each individual has a different financial situation. So, do your research and consider the following:
- Shared equity doesn’t need to be paid unless you sell or refinance a real estate property.
- These mortgages have strict rules such as limiting selling prices and the people who can buy the home.
- The goal of these loans is to make housing affordable in certain areas.
- It’s not easy getting approved for this type of mortgage.
- There are several alternatives to shared equity mortgages.