Exchange a piece of your property for additional 20% down payment
It’s not my idea; some smart people at Castle Trust in the UK are trying to get this off the ground, but I like it. It may make sense to lots of people. The company behind the so called “partnership mortgage” is still waiting for the necessary government approvals before launching a real product in the UK.
Here is what they want to do.
It is not a secret that one of the main obstacles for first time home buyers is to come up with the required down payment. It is not only a UK phenomenon, it is worldwide. As I mentioned here, this is the primary reason for Canadians to prefer renting. Even for those, who manage to get that saving nest in place and put 20% on the table, their income may not support the mortgage payment.
Castle Trust wants to step in in such cases and say “We will add another 20% down, so you have to finance only 60% or the property value”. What do they want in return? Here it becomes interesting. Your mortgage partner does not require paying interest on their share of the down payment. They do not require the money to be returned unless you sell the property or the mortgage is paid in full. In that case, your partner in the mortgage will take its 20% contribution plus 40% of realized capital gains. And more importantly, if the selling price happens to be lower, then they will also absorb 20% of the realized losses. Sounds like a good way of protecting yourself from potential falling housing values.
Nice business model. Do I see the need of such “partnership mortgage” in Canada? Of course, I do. Here is why:
If a low income family manages to scramble 20% down on a modest home of $275,000, going alone the family would end up with $220,000 mortgage. At an average mortgage rate of 4.5%, they will pay $1,217 per month. If they have a partner with extra 20% equity, the mortgage will be just $165,000 and monthly payment – only $913.
Adding a mortgage partner would generate savings of $300 per month because of the lower mortgage amount. Now, instead of spending the money, invest the $300 in a tax free saving account until you pay down the mortgage. After 25 years your saving account will have $146,991.56 (using an average interest rate of 3.5% per year). At this point your mortgage partner wants his fear share ($55,000) plus 40% of the appreciation of the appraised home value. Let’s assume the housing market goes through some rocky patches with good and bad years; however, after 25 years it may be possible the house to be valued at $400,000. The appreciation is $125,000; the 40% share will be $50,000.
When we draw the bottom line, by using a mortgage partner, after 25 years you will have:
- Your housed paid in full,
- Accumulated tax free savings of almost $147,000,
- Paid $105,000 to your mortgage partner, leaving you with $42,000 in your pocket. If the housing market is to go into a longer period of stagnation and flat home prices, then you stand to benefit even more.
Not a bad scenario…
The owner may end up at the losing end if the house value shoots up to $525,000, at which point the accumulated savings will be swallowed by the mortgage partner. How likely is that, though?
Now the big question is: Is there a financially savvy company to take such an idea and make it work in Canada? Any takers?