HomeLink | Connecting homeowners to the Yampa Valley Building Community

HomeLink Magazine

Before you hand over the keys:

A Written Agreement Is Essential

How will the total price be split when home sells?

How will the net gain be split when home sells?

Who makes the monthly payments?

Who pays the taxes and insurance?

Who gets the mortgage interest tax deduction?

How will roommate rent income be split?

What about routine upkeep, maintenance or major repair expense?

Who pays utilities?

Should there be an agreed upon end date, or exit strategy, where the borrower is required to sell or refinance?

What happens if the home shoots up in value way beyond everyone’s expectations?

If the parent/investor is on the loan, they may want to be on title.

If parent is on title, should it be as joint tenants or as tenants in common?

Will a broker be used at sale?

How will broker fees be split upon sale?

Are roommates or live-in girlfriends/boyfriends OK?

What if parent disapproves of a particular roommate?

If parents are on the loan, they may want to safeguard their credit rating and assure timely payment every month by arranging for son/daughter’s payment to be routed through, or at least verified by, them.

Will the loan be interest only or include payments of principal and interest?

HomeLink Magazine

Steamboat Real Estate - A Better Approach for First-Timers

Shared Equity Mortgages – Hitting The Housing Home Run (With A Little Help From ... My Dad?)

By Mike Larson

Local folks have long known Steamboat Springs is a great place to live. Now the world has discovered Steamboat Springs is a great place for second homes and for real estate investment in general. However, after several years of high demand and low supply, housing has become expensive. The median price for a single family home in Steamboat is over $600,000, making it very difficult for young people to buy into the market.

Because of higher housing costs, financial assistance from parents to grown children has become more common. For many, getting financial help from parents is the only realistic shot they have at buying a home in Steamboat. This article explores the concept of a shared equity mortgage. It shows parents and grown children how to use this approach to make home ownership in Steamboat more attainable.

What is a Shared Equity Mortgage and How Does it work?
Parental assistance in buying a home has traditionally taken a number of different forms. A shared equity mortgage (SEM), with parents acting as co-investors, is often the best alternative. Shared-equity mortgages are based on the idea that an investor (usually a parent, but it could be anyone) helps a cash-strapped new homeowner by contributing some or all of the down payment needed to qualify for a traditional mortgage. In return, if the house is later sold at a higher price, the parent/investor gets his original amount back, plus an agreed-upon share of the appreciated gain. When done properly, an SEM can be beneficial to both parties.

A Typical Example
Let’s say Son wants to buy a $400,000 townhome in Steamboat. He has $20,000 to put down (5%). On his own he might be able to qualify for a 95% conventional mortgage, but because of the small down payment his interest rate would be a bit higher than normal. Even worse, since he does not have 20% down, he would be required either to pay for mortgage insurance (at a cost of around $250 per month) or take out a costly second mortgage.

Instead, Parent proposes to co-invest by putting $60,000 (15%) down. The combined 20% down payment allows Son to take out an 80% first mortgage and completely avoid mortgage insurance and qualify for a very good interest rate. The negotiated agreement is that Son will pay no interest to Parent on the 15% now, but when the townhome sells, Son will pay Parent 15% of the total sales price plus 10% of any net gain.

In five years Son sells the townhome. An 8% yearly appreciation rate means the sales price is $588,000. Son had an interest-only mortgage. The townhome sold without incurring real estate commissions. Here are the numbers:

Purchase price	$400,000
Sales price	$588,000
Net gain	$188,000
Parent’s share of total sales price ($588,000 x .15)	$ 88,200
Parent’s share of net gain ($188,000 x .10)	$ 18,800
Son’s share of net gain	$ 81,000

In five years the Son’s initial investment of $20,000 has turned into an equity share of $81,000. Parent’s initial investment of $60,000 has turned into a total equity share of $107,000. Parent has received a good rate of return on his money. Son has lived in a nice place for five years, received a great return on his money, escaped having to pay any mortgage insurance, and was able to keep his monthly payment as low as possible, all while building equity in the unit. He now has $81,000 of his own money to put down on his next home.

The Up Side to a Shared Equity Mortgage
The SEM allows the Son to buy a house he could not otherwise have afforded with lower monthly payments, and a chance to grow significant equity very quickly. He’s now in a position to buy another place on his own.

The Parent benefits financially from a strong real estate market while skipping over most of the headaches. Parent avoided having to find the house, buy the house, maintain the house, and then find and keep a reliable renter. It offered Parent a chance at far better returns than a traditional parent-to-son loan at around 6 to 8%. For the Parent who cannot afford an outright gift, it’s a great way to still be able to help Son. It is a safer and more conservative means to provide assistance compared to the ways Parents have traditionally helped Sons such as making an unsecured loan, giving an outright gift, or acting as guarantor on a note. All these involve increased risk or offer reduced (or zero) returns to Parent. There may even be some tax benefits to Parent, depending on the particulars of the underlying arrangement

Perhaps most importantly, the SEM which put Son into a traditional 80% fixed rate mortgage also helped him avoid the risks inherent in using adjustable rate or option ARMS, negative amortization loans, piggyback or second mortgage loans, or other higher-risk loan products, often with prepay penalties built in somewhere. Without a 20% down payment, the riskier loan products are often the only alternatives available to cash-poor younger buyers, especially at Steamboat prices.

Things to be Aware of with a Shared Equity Mortgage
One possible down side to using SEMs is the danger that, having bought more house than Son could otherwise afford, he may now be stretched too thinly to adequately deal with things like insurance, taxes, upkeep and all the other surprise expenses that always seem to come with owning a house. A major unexpected expense can derail the monthly budget pretty quickly. Significant family tension can also occur if things go wrong. What happens if the house is neglected or damaged or the home’s market value starts to go down? Eventually, to repay Parent, Son will have to either sell the home or refinance it on his own. Who decides when that should happen? Will Parent be forced to intervene if anything goes wrong?

A Written Agreement is Essential
The possible pitfalls of SEMs bring me to the next point. SEMs are governed by private agreements that must be hand-crafted to fit the needs of the particular situation. While they can be informal and flexible, the best ones are well thought out ahead of time. It’s best to go into an SEM with a written agreement, ideally drafted by an attorney.

For most people, it’s a little scary to buy into a market like Steamboat’s. And if the investing parent is not familiar with the Steamboat market, it takes a leap of faith, given what’s going on with real estate in the rest of the country. A written agreement supporting a shared equity mortgage helps the parties think through their goals and objectives.

Parental Charity or Smart Investing?
Ironically, when parents first begin to think about whether they should help their kids buy into the Steamboat real estate market, they are not at all sure it’s a good idea, especially if they are not local, or not familiar with the mountain resort market. They think prices are ridiculously high. Surely the bubble will burst and prices will go down shortly after their kid closes the loan. Mostly, when they send in their cash, they are thinking it’s them doing the kid a favor, and there is a chance they may never see their hard-earned money again. Then a couple years later, the parents realize the “favor” was one of the best investments they ever made. The kid has actually done them the favor.

SEMs and Attainable Housing in Steamboat
The term “attainable” has become a better term than “affordable” when discussing the Steamboat Springs housing market. Although shared equity financing is usually thought of as a solution geared toward the parent/child relationship, the concept also works for other relationships such as employer/employee.

In Steamboat everyone from would-be buyers, to employers, to city councilmen, to developers has talked for years about solutions to affordable housing. The problem is that they are essentially trying to solve a free market problem with an artificial solution, such as putting deed restrictions on specially priced homes, or implementing tiered appreciation restrictions on subsidized purchases. Most of these approaches either scare off would-be buyers, or fail to properly reward would-be sellers or developers. Shared equity mortgages are a free market solution to the problem. An SEM could be of mutual benefit both to employees who need housing and their employers who need employees. In fact, there is no reason properly drafted SEM agreements could not fill critical needs in both the private and public employment sectors.

The Value of Using a Local Lender
Once you have a written SEM agreement in place and a property picked out, there are two more critical steps in the process. You need to borrow the money and actually close the deal. Making good choices about the first helps expedite the second.
In a sidebar article, Stan Urban of Land Title Guarantee Company has some advice on how to navigate the loan/title process.

Tax Considerations
Depending on how the underlying agreement is written, tax benefits can accrue to both parent as owner/investor and child as owner/occupant. While tax advice is beyond the scope of this article, some of the specific items your accountant may be interested in include the handling of rental payments, monthly expenses, depreciation, whether the home is deemed the principal residence of the parent or the child, how to best handle the mortgage interest deduction, whether there is active or passive management, and what capital gains rules come into play when the home is sold.

Win-win
A shared equity mortgage can be a great way for parents to help grown children buy into an expensive market like Steamboat. Often, parents have significant assets and the desire to assist their children, but they are not quite ready to just hand over the money. At the same time, the grown children have a legitimate need for housing, but lack the resources needed to buy into the market. A properly drafted agreement paired with a shared equity mortgage can be a marvelous way for both parents and grown children to benefit from the strong Steamboat real estate market.

Show Me the Money
By Stan Urban

Picking a lender can be a daunting task for a buyer. Knowing who to go to, what questions to ask, and then giving them all of that personal information can leave a person feeling vulnerable. While you may be tempted to go with some big-brand name from the T.V. commercials, or your friend of a friend of a friend in New Jersey, in this mountain resort you would be wise to choose a local lender—someone who knows the market and can show you the money.

Loans are not handled the same way in all states. Colorado, for instance, is a “Table Funding” state. This means the title company must have all of the money on the day of closing in order to disburse funds. Other states, called “Escrow States,” take in all of the documents and monies and then disburse funds only after the closing documents are recorded with the County Clerk and Recorder. Out-of-state lenders who do not understand Table Funding may incorrectly believe they should not fund Colorado loans until all of their documents have been recorded and returned to them. This error could delay your closing and ultimately jeopardize the transaction.

Beware, too, of Internet lenders. If your loan application, processing, and funding are handled by computer, with whom do you have a face-to-face conversation if a problem should arise? It can take days to get very simple questions answered through an Internet lender. When problems arise, they have little incentive for concern because, in every probability, they will never have to interact with you again.

Internet lenders also frequently “shop” your loan to other lenders, which can possibly have a negative effect on your credit score. Credit reporting agencies look at the number of loan inquiries you have made, and “shopping” can give the impression that you have made a lot of them. This could potentially lower your credit score, causing you to pay a higher interest rate or completely disqualify you for a loan.

Sellers should also be concerned with their buyers’ choice of lender, particularly when the sellers are using money from their property sale to purchase another property. Of course the sellers want to know the money from their sale will show up on time, but what happens when the out-of-state buyer asks his out-of-state buddy to be his lender, and this buddy is unaware of our laws and customary practices? The end result is the money doesn’t make it on time, the sellers are unable to purchase their new property, and both transactions are now at risk. Oh yes, the seller has the option to cancel the sale if the buyer’s funds are not in on time!

For all of these, and many other reasons, I strongly suggest that buyers/borrowers use our local lenders here in the Yampa Valley. They know the market, they know our laws, and they know our customary practices to make sure the money shows up and the transaction closes.