With the current economic situation many would-be first time buyers are finding it difficult to save enough money for a deposit. Asking relatives or friends for a no-interest loan can often strain relationships, as it involves a risk for the lender, with no return on their money, and no chance to earn interest on the money whilst it is otherwise tied up.
A shared equity mortgage allows a potential investor to buy a share in your property in return for a profit after the property has been resold. Of course there's a risk that the property can also decrease in value, but over the long-term, money put into real estate have proven to be an effective method of investment.
How it works
For investors, it's similar to buying shares in a company; as the value grows, so too does the value of their investment. This of course assumes that the value of the property increases, but when done correctly (e.g. buying a property to renovate), it can be hugely profitable for both parties. The best way to structure the deal is for the lender to invest a percentage of the original purchase price, with a return from the sale price for the same percentage. Also they earn a pre-agreed percentage of the 'gain' from the sale. Lets look at an example:
- The house to be bought costs £100,000, and a 10% deposit is needed = £10,000
- The investor agrees to buy a 10% stake and puts forward £10,000
- The house is later sold for £150,000
- The investor gets a return of 10% of £150,000 = £15,000
- The 'gains' is £50,000, the pre-agreed % for gains profit with the lender was set: 10%
- The lender therefore also gets 10% of £50,000 = £5,000
- Result: The lender bags £20,000 from a £10,000 investment.
- The borrowers still make £30,000 on their original property price £100,000
As you can see from the example, in the scenario that the house price rises, both parties can gain from the agreement, and it is weighted in such a way to be favourable to both. The borrowers not only benefit from an interest free loan for the time that they own the property, but they also walk away with a healthy profit to invest in a new property. And the investors make a very nice return, doubling their money.
What are the risks?
The obvious risk is that the property drops in value, and therefore the investor loses money. You could perhaps consider mitigate this, by offering to at least give the investor their original sum back in this scenario, but then this leaves you shouldering most of the risk.
That risk being of course, that if the property value drops, then the lender effectively owns a higher percentage of your property. Another risk for borrowers is that if the home shoots up too quickly in value, then the amount that you pay back might be much greater than what it would have cost you to get a commercial loan. However, if you're struggling to get finance from elsewhere, or are worried about making repayments alongside your mortgage, shared equity mortgages can help you get on the property ladder in a relatively low-risk way.
Shared equity mortgages are private agreements between borrowers and lenders, and as a such you should seek to consult a legal advisor to get a contract drawn up to protect both parties. Being named as a co-owner carries legal responsibilities, such as being accountable for a share of the property taxes and other obligations, so it's best to have an official agreement in place early on to prevent difficulties- even if it's just between family members.