What is a Shared-Equity Mortgage?

A shared-equity mortgage is an agreement by which someone buying a home gets help with the down payment from a friend or family member in exchange for equity in the home. This most commonly takes place when a parent assists a child with the initial payment and can benefit from an increase in the value of the home in later years. In a typical shared-equity mortgage, the person who helps with the down payment is usually given 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 agreement for the lending party comes if the house depreciates in value or if the borrower fails to live up to the initial agreement.

Many young adults wishing to buy a home may not have the capital to take on the down payment required to secure a fixed-rate mortgage. By contrast, their parents may have the capital to help out these potential homeowners. A simple loan doesn't provide much benefit to the lending party, but a shared-equity mortgage provides the dual service of helping the child while representing an investment for the parent.

As an example of a shared-equity mortgage, imagine that a young married couple wants to buy a house valued at $250,000 US Dollars (USD), but they have just $10,000 USD out of the $50,000 USD required 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 $40,000 USD. Since that $40,000 USD is 16 percent of the home's value, the father is granted that percentage of the resale value of the home as well as that same percentage in any gain in value at resale.

Thus, if the house managed to appreciate in value to $500,000 USD at the time the couple decides to sell it, the husband's father would be due 16 percent of the $500,000 USD, or $80,000 USD, as well as 16 percent of the gain of $250,000 USD, or $40,000 USD. That means the father receives a return of $120,000 USD on an initial $40,000 USD investment. Note that percentages are not automatically determined by the percentage loaned to the home buyer and can be set by the parties at a rate acceptable to both.

It's important to realize that there are pitfalls in a shared-equity mortgage. For example, if the family members rely on trust and don't set the agreement in writing, one side reneging on the agreement is a possibility. That could cause familial hard feelings as well as potential financial problems for one or both parties. In addition, if the value of the home depreciates, the lending party, depending on the terms of the loan, could be responsible for the drop in value.