Shared Equity Loans Explained
There is now a loan product that can assist you purchase a more expensive home or reduce your monthly repayments.
As distinct from a typical loan product, under a shared equity loan the lender assists with the purchase of a home through the provision of a loan and/or “capital”. As the name implies, the major difference between a shared equity loan and a traditional loan is that the borrower forgoes part of the capital gain upon sale of the property or clearance of the debt.
Under shared equity loans the lender may contribute up to 20% of the value of the home. For example, if you purchased a home for $500,000, the lender may contribute up to 20% ($100,000) of the purchase price without charging you interest on this amount over the life of the loan.
What are the benefits of this type of loan to you as the buyer?
- Reduce the upfront capital cost of purchasing a new home.
- Help you purchase a home of greater value than you would have otherwise been able to (due to limited servicing ability).
- Reduce the monthly repayments of a loan by borrowing less, or
- Enable you to upgrade to a more expensive home than you could normally afford as the lending institution is contributing 20% of the value of the home. For example, you may decide to purchase a $600,000 home instead of a $500,000 home to improve your lifestyle.
So what’s the catch? Why would a lender give you an interest free loan?
As the lender’s contribution is assumed to be equity in the home they participate in the capital growth. In addition to the lender being entitled to their share of the capital growth, they also participate in your share of the capital growth in lieu of the payment of interest. For example, whilst a lender may contribute up to 20% of the upfront capital value, they may be entitled to 40% of the capital gain in the home.
In summary, under the shared equity portion of the loan you are not required to pay ongoing monthly interest on that portion of the loan. As a result of this benefit, you will be required to forgo your right to 100% of the capital gain in the home and potentially only be entitled to 60% of the capital gain.
Therefore, you need to make sure that the upgrade is going to be worth it! The good news however is, if the home is sold at a loss, the lender may also share the pain of a market downturn.
There are obviously pro’s and con’s for this type of loan and it will not suit all home buyers. You need to be fully aware of the terms and conditions of the loan to avoid misunderstanding at the time of selling. It is not available for investors yet, however as the demand for this type of product grows, there may be some developments down the track.
For more information about this loan type, or for further information about your borrowing capacity, please call the office.