A shared mortgage is when a friend or family member helps with the down payment in exchange for equity in the home. The lender is awarded a percentage of the home’s resale value and gains in value. Pitfalls include lack of a written agreement and potential financial problems if the home depreciates in value.
A shared mortgage is an arrangement whereby someone buying a home gets help with the down payment from a friend or family member in exchange for the equity in the home. This most commonly occurs when a parent assists a child with the initial payment and is eligible for an increase in the home’s value in subsequent years. In a typical shared mortgage, the person helping with the down payment is usually awarded a percentage of the price of the home when it is resold, as well as a percentage of the gain in value. The danger in this deal for the lending party comes if the home depreciates in value or if the borrower falls short of the initial agreement.
Many young adults looking to buy a home may not have the capital to accept the down payment required to secure a fixed rate mortgage. Conversely, their parents may have the capital to help these prospective homeowners. A simple loan doesn’t provide many benefits to the lender, but a shared principal loan provides the dual service of helping the child while representing an investment for the parent.
As an example of a shared principal mortgage, imagine a young married couple wants to buy a house worth $250,000 US dollars (USD), but have only $10,000 USD out of the $50,000 USD needed to secure a fixed rate mortgage. They ask the husband’s father for help and he gives them the rest of the down payment, which amounts to USD $40,000. Since $40,000 USD is 16 percent of the home’s value, the father is granted that percentage of the home’s resale value and the same percentage in any gains in resale value.
Therefore, if the house has managed to appreciate in value to $500,000 USD by the time the couple decides to sell it, the husband’s father would be owed 16% of the $500,000 USD, or $80,000 USD, as well as 16% of the earnings of $250,000 USD or $40,000 USD. This means that the father receives a return of $120,000 USD on an initial investment of $40,000 USD. Note that the percentages are not automatically determined by the percentage lent to the home buyer and can be set by the parties at a mutually acceptable rate.
It’s important to realize that there are pitfalls to a shared mortgage. For example, if family members rely on trust and do not set the agreement in writing, it is possible for one party to renounce the agreement. This could cause family hard feelings and potential financial problems for one or both parties. Also, if the value of the home depreciates, the lender, depending on the terms of the loan, could be responsible for the decline in value.
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