Alternative home financing models come with trade-offs, experts say

Houses for sale in Ottawa

Be aware of what you’re giving up, not just what you’re getting in the process

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Alternative lenders are responding to Canada’s lack of housing affordability by offering a range of non-traditional financing models, including co-ownership and shared-equity mortgages, that can help would-be homeowners break into the market. But financial planning and mortgage experts warn that those considering taking advantage of such offers should be aware of what they’re giving up, not just what they’re getting in the process.

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Co-ownership models, which are among the most prevalent, are appealing because they generally lower the initial barrier to entering the market by covering a portion of the down payment upfront. By having co-investors, a potential homebuyer can reach the 20 per cent threshold needed to avoid requiring mortgage default insurance, leading to lower monthly payments. In exchange, however, the co-owner would hold certain rights to be repaid, and/or equity in the home.

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One example is Toronto-based private financing company Ourboro, which offers to contribute up to $250,000 towards a down payment, in exchange for a share of the increased value of the home when it is eventually sold.

“Once people actually understand the model, I think there’s usually an immediate kind of fear or skepticism because it’s something new and different that hasn’t really existed here in Canada before, even though it’s existed in other countries for quite some time,” said Ourboro chief operating officer Eyal Rosenblum. “But for us, it’s so, so important that we’re transparent with what it actually means to buy a home with us.”

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Rosenblum said those attracted to their model are mostly first-time homebuyers who don’t have access to intergenerational wealth and have not received money for a down payment from their family.

While they may have stable jobs, good salaries and can afford a mortgage, their lack of access to those funds is what’s really hindering their ability to break into the market, he said.

A lot of them are renters who want to get out of the rental market or find their current home is no longer suitable and want to make the switch to owning.

“They don’t have the down payment themselves, but they want to break into the housing market and to begin building equity, so they come to us,” Rosenblum said.

According to Ourboro, the down payment portion it provides is interest-free. In returns, it gets a share of the future value of a home, assuming it appreciates over time. This means whatever profit there is when it’s time for the property to be sold will be shared between parties.

For instance, if Ourboro pays 60 per cent of the down payment ($120,000) for a $1 million property, it will be entitled to 60 per cent of the home’s increased value when it is sold.

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The homebuyer, who pays the other 40 per cent of the down payment ($80,000), will need to pay for the remaining 80 per cent of the initial home price via a mortgage ($800,000). The homebuyer would then be responsible for the mortgage payments, including interest, as well as taxes, closing costs, repairs and other expenses they may incur while living in that home.

When the property is sold, payments made toward the mortgage principal will be returned to the homeowner, assuming all the mortgage was paid off. If not, the bank will be paid back first and the homeowner will get back what they paid toward the mortgage principal.

As for the remaining equity, Ourboro will own 60 per cent. For a $1 million home that appreciates to $1.5 million in value over 10 years, that remaining equity will be $700,000 after taking out the value of the mortgage principal. That is $420,000 (60 per cent of the remaining amount) going to Ourboro while the homeowner will keep 40 per cent or $280,000.

Ourboro, which is available for certain regions within and around the Greater Toronto Area, is not the only company that offers a shared equity model.

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Lotly, which has a similar model but uses a different formula, gives the homebuyer at least 51 per cent of the appreciation for its share of the down payment plus fees, while a number of non-profit entities offer other forms of shared-equity mortgages.

The CMHC also recently introduced its first-time homebuyer incentive, a shared-equity program through which the government agency would offer to take on five or 10 per cent of the value of a home, reducing monthly mortgage payments. But uptake has been limited.

Only around 20,000 borrowers in the last four years have been approved, in contrast to CMHC’s original projection of 100,000 borrowers in the first three years.

CMHC’s first-time homebuyer incentive has been an unmitigated flop

Robert McLister

Mortgage analyst and strategist Robert McLister said these types of models have not gained much popularity at this stage as not many people know about them and there are not a lot of prime lenders that support private shared equity programs.

“CMHC’s first-time homebuyer incentive has been an unmitigated flop,” McLister said.

For any kind of alternative mortgage product, it’s important for a potential buyer to take a good look at the fine print and consider some of the costs that might be involved, said Jason Heath, a financial planner and managing director of Objective Financial Partners.

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Buyers should be aware of the costs they agree to take on and those the co-owner avoids.

Some of these could mean legal and other fees that come with acquiring a home. The costs of renovations or repairs, which may help raise the home value, might also come out of the homebuyer’s pocket.

“If you’re paying 100 per cent of the renovations to your home, but you’re sharing some of the appreciation and the home value with somebody else, I think that’s something that I would be cautious of,” Heath said. The same goes for buying, selling and maintenance costs. “You need to question whether or not that’s good or bad for your own financial situation,” Heath said.

In Ourboro’s case, Rosenblum said that unlike the homebuyer, the co-investor doesn’t benefit from actually using or being in the home during that time.

“What we’re basically saying is you can live in the home, take care of it and then you cover the mortgage interest costs and you cover the cost of any of the maintenance and upkeep of the property while you’re living in it,” Rosenblum said.

McLister said he expects this type of model will appear more appealing to Canadians once the space becomes more competitive in time and shared-equity providers take smaller percentages of the upside because there’s greater competition. Until they get more profile, he said he doesn’t believe shared-equity models will make a big dent in the market.

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“Unaffordability is the base driver of these alternate solutions,” McLister said.

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Heath said that while it’s a shame people cannot afford to buy homes on their own, the existence of alternative models isn’t necessarily a bad thing, provided the risks are understood.

“I think it’s cool that innovation like this exists to be able to allow people different ways to acquire real estate,” he said.

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