Dear Rick:
I have a question that I hope you can help me with. Currently, I am divorced and I have been renting a home. My landlord has offered to sell me the home, and I very much would like to buy it. I went to a mortgage company to discuss getting a mortgage and my problem is I don’t have the money for the down payment. The mortgage company told me that unless I came up with 20 percent, I would have to pay PMI. The mortgage payment would stretch me, but I think I can afford it. The problem is the PMI would put me over the top. I tried to borrow some money from friends, but to no avail. I was told about a company that will pay your down payment not as a loan, but they take an interest in your home. My question to you is do you think this is a smart way of going? Keep in mind that I really do want this house.

Julie

A Dear Julie:
You are correct, there are companies that will provide you a down payment and in return they take a portion of the ownership of your home. For example they may take 10 percent ownership of your home so that when you sell, they get 10 percent of the proceeds. Although I can see how this service can be beneficial in some situations, there are some issues that you should be aware of.

Before I would even consider using a company that is taking an interest in my house, I would want to check them inside and out. I would want to make sure that I’m dealing with a legitimate company, because after all, they are going to have an ownership interest in your home. If the company is legit, I would also want to obtain a copy of their contract to have an Attorney review it. You cannot be too cautious in a transaction such as this.

Even if the company is legit, there are some red flags. For example, what happens if you end up selling your house for a loss? Do they share in the loss or are they entitled to something more? In addition, I would want to know whether there is a timeframe that they have to collect on their investment. In other words, are you required to refinance or sell the home in a set period of time? For example, the provisions of the deal may say that you have to cash them out within 10 years. That may cause issues for you down the road.

Some of the other red flags that I see that you want to resolve are such things as what happens if you do home improvements to your home such as remodeling your kitchen or even adding on a room. Do they benefit from that in the fact that the house would increase in value, not necessarily because of market conditions, but because of new investments. Do they share in that investment or do they just share in the appreciation of the home?

I’d also like to know if you have the option to buy out the company without selling your home. And if that option does exist, how does it work?

In a deal such as the one you’re discussing, I would always want to know how the company who’s providing you a down payment makes money. Obviously, in this situation they make money as your home appreciates. Therefore, if you’re in an area where your home substantially appreciates, it could mean over the long run, you’re paying more to the company than you would have paid in PMI. That being said, I also believe these companies make money the old fashion way in the fees they charge. You need to make sure that you understand all the fees involved, and that they are reasonable before you proceed.

On the whole, I am leery about this type of transaction. I’m not saying it’s not legitimate, but I see a lot of red flags. You need to make sure in a transaction such as this to dot every I and cross every T.

If you are to proceed, I would proceed with caution. I would also recommend that you talk to other mortgage companies. There are a variety of programs these days that reduce or eliminate PMI, and you may qualify for one of those. By using one of those programs, you may find that in the long run you have more money in your pocket because the house would be 100 percent yours and all the appreciation in the value of the home would be yours-where it belongs.

Good luck!

Rick is a fee-only financial advisor.  If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.
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