Do you represent a homebuyer who doesn’t have a 20% down payment but wants to avoid costly mortgage insurance premiums (MIPs) or private mortgage insurance (PMI)? Now there‘s another option, one that may sound familiar to our recession-seasoned readers: home equity investment.
The most recent rendition of this investment program aimed to assist creditworthy homebuyers short on cash for a down payment: REX HomeBuyer. The program allows homebuyers to use funds provided by the promoters to cover the remainder of the 20% down payment.
However, unlike traditional lenders, the San Francisco-based investment firm doesn’t call the cash a loan – rather, it’s an investment in the home’s equity by a third party.
Down the road (be it in one year or 30 years) when the homeowner decides to sell, FirstREX, which runs the program, will take a share of the gain (or loss) equivalent to the amount it invested. So if it invested 50% of the down payment, it will receive 50% of the net sales proceeds.
Only 20 homes have been purchased with REX HomeBuyer – so far. According to FirstREX, there are trillions of investment dollars ready to be put to use.
first tuesday insight
Sounds like a syndicated effort to get anxious cash investors into media driven real estate ownership.
This method of shared appreciation is another form of co-ownership, and it’s far from a new idea. In fact, it’s been tried for decades. So why don’t you hear about it very often? Because, simply, it’s a terrible idea.
This method of co-ownership creates all sorts of unacceptable conflicts. For example: how will title be held and in whose name will the purchase assist loan be recorded? As tenants in common or in an entity such as an LLC? What co-ownership agreement will be entered into permitting occupancy; a lease?
In practice, all are unsatisfactory due primarily to the inconsistent and incompatible expectations of the buyer-occupant and the co-owner investor.
What happens if the occupant makes substantial improvements to the home? Does the investor still take the same percentage of profit when the occupant sells? And who shares the gain on these home improvement investments?
Or, what if the occupant stops making payments on the mortgage? What then: eviction, and by what means? Consider that the occupant is an owner and owners have the right to possession.
On its surface, this “investment program” may seem to be a win-win situation for both the homebuyer and the investor if the many co-ownership issues go smoothly. But there is still one more likely and fatalistic condition.
Home prices must continue to rise in order for the ownership to pay off for both the buyer-occupant and the equity investor. All too many people – end users and investors — buy into the money illusion that home prices will return to that of days past and raise indefinitely, even though (recent) experience, has taught us otherwise. And the current home price rise is speculator-driven, likely to fall back by the end of this year as did the stimulus (and speculator) driven price rise of 2009.
When prices flatten and drop, interest in the ownership tends to dissipate at about the same rate – witness the nearly one million homeowners in California that let their homes go during the past decade.
Financially, homeownership is at best a hedge against consumer inflation, and then only so when the purchase price paid is close to the mean price level over a business cycle; homes simply are not an ever-appreciating asset soaring beyond inflation into perpetuity — history is your evidence for this. It is dangerous for owner-occupants and investors to assume so.
Personal incomes rise only at just above the rate of inflation in California. In turn, income controls the amount one can pay for a home. Yes, a decline in interest rates will directly increase the price a buyer pays for property, and going forward there is no way for interest rates to drop over the next couple of decades as they have during the past 20 years.
Another thing to consider: if a potential homebuyer doesn’t have sufficient cash reserves for a down payment, are they really the best candidate for homeownership? Easy financing from investors for unqualified homebuyers was one dilemma that led to the Millennium Boom and subsequent crash.
Consider the investor in an equity sharing ownership plan being in the same position economically (not legally) as the sandwiched piggy-back loan resting between the first mortgage and the buyer-occupant’s meager skin in the game. Bad then; bad now. Impatience by both the end user and the investor is the culprit.
The forthcoming qualified residential mortgage (QRM) requirements will likely demand a hefty down payment from all future homebuyers. The QRM’s purpose is solely to avoid another boom and bust – trying to get around it only perpetuates bad habits that will surely lead us down that boom and bust road once more.
Whether or not you recommend this program to your homebuyer clients is up to you. But as a prescription for cash-strapped homebuyers, first tuesday does not endorse this type of home equity investment.
Homebuyers (and potential investors) need to view homeownership primarily as an investment in shelter, not as an easy money-making investment. Better to structure the equity sharing deal as a loan from all points of view, legal and economic. Those who act otherwise do so at their peril. [See first tuesday Form 430 Share Appreciation Note – Installment – Contingent Interest Extra]
Re: Equity investment program can help you buy that house from The Los Angeles Times