For aspiring homeowners, coming up with a healthy down payment has long been the biggest obstacle to owning a home.
With property values soaring in many areas — median prices in San Jose, California, and Denver are 60 percent above their pre-recession peaks — the barrier is rising. That has some firms promoting unconventional ways to scrape together a down payment, including crowdfunding and using Airbnb rental income.
Now, a small but growing number of homebuyers are trying something different: asking an outside investor put down money alongside them.
It is called shared equity, and Unison, a company based in San Francisco, is the largest of a handful of firms putting it to work. Unison will provide at least half of a consumer’s down payment in exchange for a piece of any appreciation in the home’s value when it is sold. If the home sells at a loss, the company absorbs a share of that, too.
Until the home sells, Unison is mostly a silent partner. The homeowner pays taxes, insurance and all other necessary costs.
The idea behind the program is to provide homebuyers with more options. It can help those who are short on down payment funds increase their buying power, though it may also work for people who simply do not want to sink every last dime into their homes. But whether it is right for any individual buyer — upfront cash now versus less proceeds later — is a difficult and highly personal calculation.
Most first-time homebuyers put down only about 7.4 percent, on average, according to Inside Mortgage Finance. Although there are plenty of programs that permit small down payments, they can substantially increase monthly housing costs.
Unison and its competitors help increase a down payment to 20 percent of a home’s purchase price — the magic number needed to qualify for the best interest rates and to avoid the added cost of private mortgage insurance.
But relying on an outside investor challenges traditional attitudes about homeownership, even if the conventional approach may be just as risky: Where else in our lives are we encouraged to plunk a huge piece of our net worth into a single asset? The same sort of behavior would be considered reckless in a retirement portfolio.
Shared equity also raises a fundamental question about our overall approach to buying homes, given that the average homeowner moves after about eight years.
“Why do households have to choose between renting their homes and buying them outright?” asked Andrew Caplin, an economics professor at New York University who co-wrote a book 20 years ago about how shared equity markets could benefit homeowners. It should not be an all-or-nothing proposition, he said.
Giving up a stake in your home to diversify may make sense in theory. The question is at what cost, and whether the average person is in the position to figure it out.
For these programs to be adopted broadly, they would need the support of Fannie Mae and Freddie Mac, the government-controlled entities that buy most conventional mortgages. Both are trying new ways to get people into homes, particularly younger adults coping with student loans, rising rents and increasing health care costs. Freddie Mac is working with Unison on a pilot program, but it is unclear whether it will expand widely.
For now, shared equity deals are a droplet in the giant pool of new mortgages. Unison, which operates in 22 states, said it had invested alongside 450 homebuyers last year, and was on track to invest with roughly 2,500 to 3,000 more in 2018. It has an investment management arm, and its investors — mostly pension funds and university endowments seeking a return slightly above inflation — provide the money for the down payments.
Unison’s costs and approach vary slightly from those of its competitors, including Landed, which offers a similar service for public school employees, and Own Home Finance of San Marcos, California.
Here is how Unison’s program works.
• The background. Shared equity started as a way for people with low and moderate incomes to buy homes. The latest incarnation is geared toward those with solid incomes who can qualify for a traditional home loan or even a jumbo mortgage.
Unison began in high-price markets like California, so most people using the program are at least in their 40s with incomes between $75,000 and $150,000. The company said it expected those numbers to fall now that it had branched into different areas.
• The process. Unison teams up with specific lenders that homebuyers must work with. Applicants must qualify for a mortgage, and the home must be one that Unison wants to invest in. That generally means it has to be “typical” for its neighborhood. A McMansion on an acre plot amid more modest homes may not qualify.
The company will invest in single-family and multifamily homes with up to four units, and in town houses and condominiums. To discourage the quick flipping of properties for a profit, Unison requires buyers to occupy the properties, but they can sell whenever they want.
• The structure. Unison’s portion of the down payment is not a loan. No payments are made; no interest accrues. The company’s agreement with a homebuyer is structured as an option contract, with its investment effectively giving it the right to buy a stake in the home at a later date, typically when it is sold or after 30 years, whichever comes first. So if the company contributes half of a down payment, it collects over a third of any appreciation in the home’s value (in addition to the original sum it invested).
A homeowner can sell at any time, but Unison absorbs a loss only after three years of ownership. Alternatively, the homeowner can buy out Unison’s share — at a price based on an independent appraisal — although that is permitted only after three years. In such instances, Unison does not share in any losses.
• The rules. Homeowners generally cannot draw on their home equity beyond the amount of the original mortgage. And they must cover the entire cost of any renovations, although Unison credits the value the work adds to the home’s ultimate sale price. Conversely, there can be repercussions if a home is not well maintained.
In the event of default, Unison — which places liens on the properties it invests in — has the right to foreclose to protect its stake. More often, company executives said, it may step in to help settle arrears and to initiate a more orderly sale — at a price.
• The math. Consider a family buying a home in Atlanta for $500,000. The homebuyer and Unison each put down 10 percent, or $50,000, for a total of $100,000. (The company also charges an origination fee equal to 2.5 percent of the amount it provides, so it would essentially provide $48,750 in this example.)
Seven years later, the home sells for $575,556, 15 percent above the purchase price. Unison gets back its initial $50,000, plus 35 percent of the price appreciation, or $26,444, for a total of $76,444. The homeowner walks away with roughly $108,000, after selling costs. That figure includes equity and roughly two-thirds of the increase in value.
If the same home sold for $469,000, a loss of $31,000, or 6 percent, Unison would offset some of that. The homeowner would absorb only 65 percent of the loss, keeping $46,600 after the sale versus only $35,720 if Unison were not involved.
“In really negative return scenarios, Unison gets wiped out completely,” said Paul Tucker, the company’s director of business operations, “but our loss is capped at our initial investment.”
• The calculation. Consumers who apply for the Unison program should consider how much they may save on their monthly payment over the time they expect to stay in the home. The hard part is the back end of the calculation, or what they may give up in appreciation.
“You can’t really know the true future cost until the future actually comes,” said Keith Gumbinger, vice president at HSH.com, which tracks the mortgage market.
Brett Theodos, a principal research associate at the Urban Institute, said shared equity appeared to make the most sense for people living in the priciest areas, or for those unable to buy without help.
“If you truly can’t afford to do anything other than rent, you will build more equity with shared equity than you would have as renter,” Theodos said, adding that he was not sure whether such arrangements were the best option for people in more affordable areas. “Whether this makes sense for Wichita and Duluth or even Chicago? I am less sure.”
Theodos also said there was something else that homebuyers should not ignore.
“Investors are looking for a way to make money — most people’s wealth is in their home,” he said. “That is not a fully tapped market.”