Banker’s Hours column: Equity sharing is a new twist on an old concept
Rising home prices mean that, when a purchaser buys a new home, a bigger down payment is required, which can limit a prospective homeowner’s buying power. An otherwise qualified buyer, with sufficient income and good credit, may not have the liquidity to secure the best mortgage.
Equity sharing is a new twist on an old concept that can provide additional cash for a homebuyer, and does it much more cheaply than mortgage insurance, either government or private, which can get fairly pricey.
Generally speaking, if a buyer can put 20 percent cash down, no mortgage insurance, which insures the loan against default, is required. But loans above 80 percent of the purchase price generally do need it, and at 90 percent or above, virtually all do.
Equity sharing involves a financial services company that puts up, say, half the down payment, and then participates in up to 35 percent of the subject property’s appreciation when it’s sold. In a rising market, this works pretty well for everyone. The homeowner gets a chunk of money to buy the house of his or her dreams, pays no interest on that money, repays it only when the home sells, and doesn’t pay extra for mortgage insurance while in the property.
But this is a market bet for the equity sharing company. Thirty-five percent is a sweet payday on the upside. What about the downside.
Well, that’s not so sweet, because the business that provided that 50 percent of the down payment, say, five years ago, is last in line, right along with the homeowner. Well, not exactly last. The owner would owe the company its share of the loss, although the company would not be a lien-holder at any foreclosure sale but in the position of an unsecured creditor.
Shared equity cash can be used by people that already own their homes, and work like a cash out refinance. The owner gets cash, and assigns a share of the property’s equity to the provider of the money. Since it’s not a debt, the arrangement needn’t be listed on the homeowner’s financial statement.
We said this is an old concept, and it’s one of the oldest: Someone doesn’t have the cash to swing a real estate deal, so they bring in a partner. In the English speaking world, since 1066 when William the Conqueror eschewed partners and simply took England from Harold, land has generally tended to appreciate in value, since it’s a finite commodity.
A recent example of this was the 1970s and early ’80s, the years preceding the Savings and Loan Crisis (a touchingly quaint debacle, given what happened in 2008).
In those days, S&L’s were going nuts, because they weren’t making as much money as commercial banks. About all they could do was make home loans, construction loans and land development loans. Some regulatory changes opened the door for them to have so-called service corporations that could actually invest in real estate. And many of them did it in a big way.
They partnered up with builders and developers so that they, the S&L execs, could get rich just like the builders that they’d been financing for years with only a paltry 3 percent return, after the S&L’s cost of money.
Needless to say, the developers were hanging around the bus station. They spotted the pink-cheeked S&L presidents the minute they stepped out of their corner offices and headed for the golf course. The rest, as they say, is history. The stock market took a dive in ’87, and real estate markets, especially in urban areas, followed suit. Hundreds of savings and loan associations went broke.
It’s 2018, and 2008 is a distant memory — after all, it was 10 years ago. That’s ancient history. That was before Twitter, for crying out loud. There’s a housing shortage, haven’t you heard? Real estate markets are healthy in most of the country, and sizzling in the really desirable venues. Values are rising, and equity sharing is where it’s at.
That is, until the music stops, and a lot of people are left with no place to sit. Sound familiar?
Wait. I’m looking this up in the “Official Sayings of Yogi.” Yep, here it is, right here on page 179.
“Déjà vu all over again.”
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is email@example.com.