Buying a home can be a challenge for many reasons, especially the financing part. House prices have risen dramatically over the last decade, while incomes haven’t. Combine that with self-employment and the gig economy now accounting for 15% of total employment in Canada (up from 12% in 1988) qualifying for a mortgage is getting harder and harder.
In the face of all this, Canadians are understandably looking for creative ways to finance their homes. Millennials especially are more likely to buy with a partner or friend, use gifted money from family, and use rental income to offset their mortgage payment. And now a new idea has started to enter the lexicon: a shared equity mortgage.
What is a shared equity mortgage?
A shared equity mortgage is where your take a smaller mortgage, in exchange for your lender owning some equity in the home. You’ll become a co-owner of the property alongside your bank lender. You’ll get to live in the house, but only borrow a fraction of the purchase price. When you sell the house, you’ll share the profits and losses from the sale with the lender, in line with your equity share.
It’s worth noting that a shared equity mortgage is different to a joint mortgage, where two or more people own and generally live in the same home. There are pros and cons of joint mortgages, so be sure to do your research.
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A shared equity mortgage example
An example will help make this easier to understand. Let’s say that Sarah is a first-time home buyer, and is considering whether to buy a $600,000 home with a traditional mortgage or a shared equity mortgage.
Sarah’s traditional mortgage
In a traditional mortgage, Sarah’s new home would be collateral for the loan. She’ll need a down payment saved, ideally 20% or more, and her lender will issues a mortgage for the rest of the purchase price. If Sarah defaults, her lender can take the home and use it to get their money back through foreclosure or power of sale. But, as long as Sarah makes her payments on time, the home will eventually belong to her alone. Under this arrangement, Sarah’s monthly payments with a few different interest rates are below. We used our mortgage payment calculator to crunch these numbers.
|5-year fixed rate||Amoritization||Mortgage required*||Monthly payments|
*The $600,000 asking price, minus a 20% down payment
Sarah’s shared equity mortgage
In a shared equity mortgage, the lender actually owns part of Sarah’s home. When Sarah sells the home, her lender shares in the sale price, based on their percentage of ownership – profits and losses are shared by both parties. Even after your mortgage is paid off, the lender still owns a share of your home.
Here’s what Sarah’s payments would look like, assuming the bank took a 10% stake in her home:
|5-year fixed rate||Amoritization||Mortgage required**||Monthly payments|
**The $600,000 asking price, minus a 20% payment and the bank’s share
Why use a shared equity mortgage?
There are two advantages to shared equity mortgages, both geared toward affordability. First, the size of your mortgage will be smaller with a shared equity mortgage than a traditional mortgage. Because the lender is purchasing a portion of the home, you only have to mortgage the remainder. Since your upper limit is based on how much mortgage you can afford, this could help you afford a home with a bigger purchase price.
Second, your monthly payments will theoretically be lower, because you only have to repay the amount you borrowed. Alternatively, you can choose to accelerate your payments and pay off your mortgage faster. Since mortgage affordability comes down to a percentage of your income, having a smaller mortgage with lower payments makes it easier to qualify for the home you want.
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How can I get a shared equity mortgage in Canada?
Outside of private arrangements (usually agreed to between family members), there is currently only one shared equity lender available in the Canadian market: the first-time homebuyer incentive. Using this program, first-time homebuyers can access an interest-free shared equity loan for up to 10% of the purchase price of a new home (or 5% of the price of a resale home) to top up their down payment. The loan must be repaid when the home is sold, or after 25 years.
There are some strict criteria to participate in the program, however. Household income can be no more than $120,000, the buyer can only purchase a home worth four times their income, and the borrower must have at least a 5% down payment.
There’s also the catch that as a shared equity loan, the government technically owns a 5% share in your home. When you sell the home, you have to pay back 5% of the amount you sell the home for – even if it’s significantly more than the amount you borrowed in the first place.
Is a shared equity mortgage a good idea?
Not always – and the the first-time homebuyer incentive is problematic in its current form. The problem with the incentive is that it actually limits affordability for first-time homebuyers. A couple in Canada with a $100,000 household income and a 5% down payment can qualify for a mortgage on a home worth $479,888. But under the program, they’re limited to a purchase price of $400,000.
The program also diminishes your ability to grow your net worth. As your home’s value goes up, you only benefit from the portion of the home you own. So, a portion of that growth will go back to the government at some point. Of course, if the value of your home falls you’ll have a small cushion against the loss.
If you’re planning to spend less than 4x your income on a home, and you’re comfortable losing a portion of your potential equity growth, the program could work well for you. But if you want to spend more on your home, can comfortably afford to purchase a home without participating in the program, or just don’t want an extra loan hanging over your head, you might want to pass.
What other options do I have to afford the home I want?
There are a few other programs for first-time homebuyers that can help you afford your first home. They include the RRSP Home Buyers’ Plan, which lets you use your RRSP to save for a first home. There’s also the home buyers’ tax credit, which gives you a $750 non-refundable tax credit in the year you buy your first home. Some provinces and cities also offer land transfer tax rebates for first-time homebuyers.
Outside of government programs, your best option is to use your time and money wisely. Saving more money for longer is the best way to increase your down payment. Reducing your debt as much as possible can help you qualify for a bigger mortgage. And increasing your income (easier said than done) can directly increase the size of mortgage you can get.
Unfortunately, while Canadian mortgage rates are still near all-time lows, getting a better rate won’t help you qualify for a bigger mortgage. That’s because affordability is calculated using a benchmark rate that’s much higher than the rate you’ll actually pay. Of course, comparing mortgage rates to get a great deal can still save you thousands of dollars!
The bottom line
To get started on buying your first home, check in with a mortgage broker. They can help you understand exactly what you can afford, and the steps you can take to afford the home you want. They can also give you solid advice on whether the first-time homebuyer incentive is something you should participate in. When you’re ready to get a mortgage, a broker can do the negotiation part on your behalf so you get the best mortgage rate without having to shop around at all the banks.