October 1, 1999

Taking on a partner in buying a house

By TOM KELLY
The Real Estate Advisor

Remember when "CD" simply stood for a certificate of deposit? Now, the first notion -- even for a bankers and reporters -- conjures a picture of a compact disc player. The only real question is whether it is to be placed in the bookshelf of the family room, held during exercise or fit snugly in a computer or car.

That's why our speakers panel was startled when a young man asked at a recent homebuyers' seminar if it were wise to "throw his $100 monthly savings at a CD."

Foolishly, I replied: "No, every little bit helps. Try to save it for the downpayment for a home."

"That's precisely what I'm doing," the man said. "What I am asking is if a CD is a good place to have it for right now."

We all were embarrassed because of our immediate CD impressions. However what was clear was the man was focused on buying a home. He was proud of his ability to save -- and he should be. Given today's demands and wants, it's difficult to save $100 a month.

The downpayment remains the deepest chuck hole on the road to home ownership.

First-time buyers, folks starting over after divorce or bankruptcy, have more workable, flexible loan programs today than even three short years ago. One lender, who recently spoke to college seniors regarding realistic paths to buying their first home, showed that saving $100 a month for five years would give them a down payment of $6,000, not including interest accrued.

Depending on the loan program, income and credit history, the $6,000 could be all or part of the down payment for a lower-end, single-family home or a mid-level townhouse or condominium (both priced at about $150,000).

One path that was used several years ago that was raised to our panel was known as equity sharing. The concept still surfaces periodically yet it has virtually disappeared because of the low-downpayment and zero-downpayment options available today.

Flexibility brought the stark truth to the table: Why share the pie when a lender is willing to let you borrow 97 percent of the purchase price on owner-occupied houses?

Some potential home buyers, seeking all possible methods of getting in the door, found private investors willing to share the cost of the home in return for future appreciation.

The need for equity sharing was originally shaped by credit. Under the guidelines that govern most lending institutions, persons who have either cash but no credit or credit but no cash do not qualify for home mortgages at affordable rates. The lender's position is understandable -- they are using money from their depositors and must exercise caution when granting a loan.

An investor, however, is usually using his own funds and can be more tolerant of money and credit problems. A popular example of this practice is seller-financing. The seller may "carry the contract" for a buyer instead of the buyer obtaining financing from a lending institution.

The concept of equity sharing, an often misunderstood and confusing vehicle of financing, was too complicated for the average first-time home buyer. However, it's still common in investment property.

When obtained through the assistance of a reputable investor, equity sharing could be a profitable venture for both parties.

In investment (rental) property, a cash-poor buyer who knows of a good investment often seeks a partner to "front" the down payment. The two form a partnership to share the profits of the sale.

Generally, there are three principals involved in an equity-sharing agreement in an "owner-occupied" situation -- a lender, investor and purchaser. The investor negotiates and secures a loan from the lender and buys the property. The purchaser (with little up-front cash) then buys the property from the investor. Those two parties then share in the profits from the increase in equity over a predetermined period of time, normally five to seven years. The investor puts up the money for the down payment while the purchaser lives on the property, maintains it and makes the monthly payments. Both investor and purchaser share major repair bills, depending upon the agreement and who is occupying (purchaser or renter) the home.

The investor often makes about 50 percent on his initial investment, plus tax deductions on interest taxes and depreciation. The buyer gets into a home for little up-front cash, while enjoying part of those tax benefits and the chance to establish credit.

The part of the deal that's probably the most misunderstood is the ownership split. The purchaser does not automatically get a 50 percent stake in the property. Typically, the purchaser gets 50 percent of the increase in equity over a specified period of time.

Before taking on any partners, take an honest gauge of how much you can save. If you "throw it at the right CD" your downpayment may grow faster than you think.

Previous columns:

• Do you really need a broker?, 09-24-1999
• Two new options for homebuyers, 09-17-1999
• Sears kit houses are still around, 09-10-1999
• Feng shui analysis hits home, 09-03-1999
• New book shows the lighter side of lending, 08-27-1999
• A new way to hunt for a home, 08-20-1999
• Mortgage rates up, but why?, 08-13-1999
• Insurance changes apply to new loans, 07-30-1999