What Exactly is a Home Equity Sharing Agreement?
Home equity sharing agreements are contracts between homeowners and outside investors (often venture capitalists, angel investors, or institutional investors) that allow for a shared stake in the value of a home. When property values increase, the investor receives a percentage of value appreciation in the home. Alternatively, when property values decrease, the investor agrees to take a loss instead of the homeowner. In this way, home equity sharing agreements function a bit like call options on stocks, allowing homeowners access to additional equity without taking on debt in the form of a mortgage or a home equity line of credit. For example, let’s say a homeowner is looking to sell his home for $250,000, but he only paid $150,000 and so has little incentive to do so—after paying realtor fees, he would be left with less than $100,000, which might not be enough to purchase a comparable replacement home. Adding to the problem, homeowner can’t afford a new down payment on the replacement home because his equity is tied up in the home he is currently selling .
Let’s say a home equity sharing investor agrees to foot the $100,000 down payment on a new home in exchange for 50% of the appreciation in the property values the two year period covered by the contract (the duration of the contract is negotiable). If home values increase to $300,000 in two years, the investor will get $125,000 (the $50,000 increase in home value goes 50/50 to the investor and $50,000 goes to the homeowner as his stock in the house). If home values decrease to $200,000, the homeowner will get 50% of the $100,000 decrease ($50,000). Essentially the investor and the homeowner are splitting the risk and reward associated with the ownership of the home. These agreements are not insurance products (although they might be referred to as such), and this is what makes them different from more traditional financing products like home equity lines of credit (HELOC) and reverse mortgages. These products, while they can both be used to access funds from your home equity, require repayment with interest. They also do not have the flexibility that a home equity sharing agreement does because their terms are fixed (instead of being duration being negotiable, as with home equity sharing agreements).
Basics of a Home Equity Sharing Agreement
The key components of a home equity sharing agreement include the terms of the agreement, percentage shares, responsibilities of each party, and provisions for conflict resolution.
The terms of agreement will include the duration of the agreement, when parties can exercise their options, and how payments are calculated and secured. This portion essentially lays the groundwork for what is expected of each party, in terms of actions and obligations. The percentage shares determine how the costs and profits will be divided between the parties. The percentages will be crucial when making decisions on BIG questions at the end of the agreement, such as when the options are exercised and one party pays the other their share of the equity, or when they sell the home and must divide the profit. The responsibilities of each party, particularly in regards to upkeep and mortgage payments, are essential to the agreement. Parties should be clear on who will handle these costs and how, to avoid conflict down the road. The conflict resolution provisions can be more extensive or more basic, depending on the parties. Dispute resolution clauses can provide detailed descriptions of how to handle the different types of disputes, or they may simply dictate mediation or arbitration before litigation. Having at least a basic description of how to solve disputes should be included in the agreement.
The stakes are high so take time to draft the details of your equity sharing arrangements. Make sure to address issues such as the cost of insurance and various other real estate taxes (such as school taxes). You will also need to address the scenarios when you agree to sell or refresh your agreement and be clear about your ability to exercise your options and the impact this will have on each party.
Drafting a Home Equity Sharing Agreement: Free DIY Guide or Paid Help?
For the DIYers out there looking to save some money, creating your own home equity sharing agreement may sound like the way to go. After all, we’ve given you a general template (with a few common issues and our suggested verbiage to consider) to use as a guide, and a review of the many potential costs and expenses in entering into a sharing agreement. But it’s important to think about whether or not you are more comfortable going it alone or enlisting the help of legal professionals to help navigate the process.
In general, if you have fairly simply arrangements with your buyer that mostly involve simply sharing housing costs, and you are both of sound mind and in good standing with one another, a DIY approach might be for you. For example, perhaps you have spent the last ten years living with your senior parents because it made sense for both of you: mom and dad were getting older and needed some help, and you had been renting and desired a stable place to raise your family. Or, perhaps you and your best friend are tired of paying so much money to some landlord, and you want to buy a place of your own so you can keep your money. Or maybe one of you has accrued a large enough down payment, but cannot afford the recurring housing costs on your own due to reduced income, and the other party is buying in to help out. Under these circumstances, you might have a fairly simple agreement that only covers basics, like what monthly costs each user will pay and how to split any major repairs or improvements.
On the other hand, if this is a second order, or even third order, relationship (i.e. a friend of a friend, or a sibling-in-law), perhaps you do not know the other party that well or how they will behave under certain circumstances. Or, perhaps the parties desire a more sophisticated arrangement where each party holds a specific ownership interest, and that ownership is tied more closely to, say, annual rental income, so that each party benefits from the rise (or loss) in value of the home. Perhaps the parties will want to try to market their respective rental paid as an investment opportunity down the road – having an agreement in place minimizes potential disputes about who gets to do what.
Ultimately, the initial costs of hiring a professional to draft up a home equity sharing agreement are likely to be far less expensive than the costs of dealing with a dispute down the road. For example, let’s say Mom and Dad have no equity in their house, but pay $500 per month toward housing costs. Son agrees to pay an additional $300 per month for his one-half of the home’s housing costs, but we know that the costs are actually more like $1,200 per month. Because the parents are not on title (and thus, have no claim to any increase in value), Mom and Dad can only retain their share of the $500 per month in housing costs, leaving $200 per month to be paid to the home equity company. That means that the son’s share of the monthly costs would be $800 per month, so he says "forget it, I need a rent-controlled apartment." Then Mom and Dad sue the son, alleging he has taken unfair advantage of them. Unless there is a home equity agreement in place, how are you going to calculate the damages owed? If the son lives elsewhere but still needs to pay his mother for rent, how is the rate of rent determined? When the son hears his parents are moving out of state, how will he get his equity back into his hands? Or, worse, without somthing in writing, what if Mom and Dad default on their mortgage or decide to move to a different neighborhood without telling Son? Is it fair to divide the equity down the middle, when the son has paid significantly more into the house than his parents? Conversely, like in many family home sales, what happens if Mom and Dad refuse to update the home equity agreement after getting their retirement dream home, because son a is a "money grubbing thief" for making them pay a slightly higher rate of rent than the apartment they could have gotten for free in the same neighborhood? As such, we hope you think about these potential questions at the outset of your home equity sharing agreement (or even before you pitch the idea to someone you have always wanted to live with).
Risks in Home Equity Sharing Agreements and How to Prevent Them
One of the most common pitfalls people make with this document is not being transparent with the co-buyer or co-investor. Make sure both parties understand the terms of the contract, not only at the time of the deal, but also in case the house value changes in the future, interest rates increase to a higher rate or the owner wants to refinance.
Not having a "good guy" clause may create headaches later on, which are hard to fix, because all lenders have their own policies and procedures. Remember that lenders have both the right and obligation to protect their investment, and if you or your lender try to do this outside common protocols, it’s likely to fail.
Finally, all good home equity sharing agreements should contain provisions for when the house sells, and the parties split the sales proceeds.
Home Equity Sharing Agreement Legalities and Guidance
When entering into a home equity sharing agreement, there are several legal considerations to keep in mind to ensure the agreement is legally binding and protects the interests of both parties involved. It is essential for parties to adhere to certain best practices, such as:
- PUT IT IN WRITING. Equity sharing agreements can be easily misunderstood. Thus, a written document that clearly outlines the obligations and responsibilities of each party in the equity sharing transaction will protect both parties against disagreements. Furthermore, the written document can be registered to title, and thus, enforceable even in the even the case of demise of the other party.
- USE A TITLE COMPANY: The parties to an equity sharing agreement are usually not lawyers , and therefore, may not be familiar with the proper procedures for executing the underlying documents to effect the transaction, including but not limited to the deed and mortgage. A recognized title company can lend expertise to ensure that the appropriate documents are correctly drafted and unnecessary delays are avoided.
- HIRE AN ATTORNEY: A lawyer can lend expertise in reviewing the equity sharing agreement, and offer advice and guidance for any potential pitfalls. An experienced attorney can also provide the parties with an independent perspective on the fairness of the agreement, and may highlight certain pitfalls that the parties may have overlooked.
Utilizing a Home Equity Sharing Agreement Template
Home equity sharing agreements can be a useful tool for real estate investors seeking to purchase properties with little or no money down. A home equity sharing agreement template can make this process easier and ensure that you have all the information and clauses needed to make the agreement work for your specific situation. Start by taking the time to review and understand the clauses in the template. Look up any legal terms you don’t understand to ensure that you fully understand the legal implications of each clause.
Then, fill out the template, providing all of the information requested in each section. Make sure to include the names of the owners and investors, the address and description of the property, and the purchase price in the appropriate sections of the template. If there are any other details relevant to your agreement with the buyer or seller, you can add them in the spaces at the end. For example, if the sellers are offering to pay some of the closing costs or the buyer has alternative financing options, include those details wherever you find it makes sense.
Once you’ve filled out the template, read the entire document through out loud and make any adjustments as necessary. You may also find it helpful to have someone else review your agreement. This can help ensure that you haven’t missed any key details or important clauses. Before signing the agreement, read through the entire document a final time to check for mistakes or missing details. Only then should you sign the agreement.
Having a home equity sharing agreement template for real estate investing offers many advantages. It allows you to provide investors with a way to participate that doesn’t require a large, liquid cash investment. It can also allow you to ensure that buyers do not default on the agreement.
Template for Home Equity Sharing Agreement
THIS AGREEMENT dated the ______ day of ____, 20__.
BETWEEN:
[HOMEOWNER’S NAME] of [HOMEOWNER’S ADDRESS] (the "Owner")
AND:
[INVESTOR’S NAME] of [INVESTOR’S ADDRESS] (the "Investor")
IN CONSIDERATION of the mutual agreements and covenants contained in this home equity sharing agreement (this "Agreement"), the Investor hereby acquires an amount equal to xx % of the equity in the property located at [ADDRESS OF SUBJECT PROPERTY] (the "Subject Property").
1. PREAMBLE.
The Owner intends to purchase the Subject Property with the proceeds of a bridge loan in order to acquire and profit from the appreciation of the Subject Property. Further, the Investor, who is in the business of investing in home equity loans, intends to acquire an investment interest in the Subject Property secured by a second deed of trust on the Subject Property until the loan made pursuant to an implied agreement between the Owner and Investor is paid in full.
2. LOAN COMMITMENT.
The Loan Commitment in a principal amount equal to $______ is made pursuant to the terms and conditions attached hereto as Exhibit "A" and incorporated herein.
3. LOAN SECURITIES.
The Loan shall be secured by a deed of trust on the Subject Property (the "Loan Security"). At closing, the Owner agrees to execute and deliver:
(a) A grant, bargain and sale deed to the Investor, conveying to the Investor, and granting a perfected lien or security interest, upon all equity in the Subject Property, subject to all existing and future governmental and other public assessments, covenants, conditions and restrictions of record, and all other recorded matters of record affecting the Subject Property; and
(b) A deed of trust representing a first position perfected security interest upon all equity in the Subject Property, subject to all existing and future governmental and other public assessments, covenants, conditions and restrictions of record, and all other recorded matters of record affecting the Subject Property.
4. LOAN PROVISIONS .
The Loan is subject to the following terms and conditions, and the Owner and the Investor agree to comply therewith:
(a) The Loan shall be pre-payable in whole or in part, without penalty, in the sole discretion of the Owner at any time.
(b) The Loan shall be repaid in full at the earlier of one calendar year from the date of inception or upon concurrent consummation of sale of the Subject Property.
(c) The Owner shall make payments of principal and interest on the Loan in accordance with the terms of the Loan Commitment.
(e) In the event the Owner damages, destroys or otherwise physically decreases the value of the Subject Property, the Owner agrees to pay the Investor a sum equal to the diminution of value not later than the fourth day after the Owner becomes aware or is deemed to have become aware of such damage, destruction or diminution of value, and the proceeds of any insurance policy allocable to the loss of value shall be deemed to be for the account of the Investor, unless the Investor elects to make repairs with such funds.
(f) In the event that the Loan is in default, whether matured or unmatured, or another event of default hereunder occurs: (i) the Investor shall have the right to foreclose its Loan Security upon the Subject Property and to exercise its rights in respect thereof under applicable law (including the Uniform Commercial Code); (ii) the Owner’s obligations under this Agreement shall continue in full force and effect; (iii) the Owner shall be liable for, and shall promptly pay, on demand, any expenses reasonably incurred in connection with the collection or enforcement of its obligations hereunder, including reasonable outside attorneys’ and other professionals’ fees and expenses and the costs of auditing this Agreement; and (iv) the Investor shall have all rights and remedies available at law or in equity; and (g) The Loan shall bear interest at the greater of (i) the Wall Street Journal prime rate published on _______ , as such rate from time to time changes; or (ii) 5% per annum.
This Agreement shall be governed by the laws of the State of [STATE].