YOUR MORTGAGE - A new take on gift of equity: Turn it into an investment
Gifts of equity within the family are common. Parents often provide the down payment on their child's first home purchase. Many parents, however, can't afford a sizable gift; among other things, they may be concerned about the adequacy of their assets for retirement. Yet they might welcome an opportunity to help their children if it took the form of a reasonably safe investment yielding an adequate rate of return.
A house purchase by a family member may provide such an investment. Over the years, I have advised a number of families who asked me about how to set up a plan that would meet their particular needs. I even wrote a few articles describing such plans.
Usually, the investor contributes to the down payment, but some home buyers may need help with the monthly payment as well. In addition, the investor sometimes is a co-occupant, though not necessarily for half the house.
I have come to believe that there is a large untapped market for intra-family investments in house purchases. The reason that so few actually materialize is that every deal is different, and designing it properly is very complicated. To remedy this, I have developed a spreadsheet at www.mtgprofessor.com that accommodates a wide variety of preferences of the home buyer and the investor.
The spreadsheet calculates the percentage of the home equity (property value less mortgage balance) that is owned by each party at the end of each year. The respective ownership shares depend on the amount they each contribute to the initial cost of the home, the amount they each contribute monthly, the rent that is credited to the investor, and the interest rate that is used to calculate the future value of each party's contributions, including the rent credit.
The spreadsheet has two purposes. First, it is a simulation tool that allows the buyer and investor to see how each will fare under alternative combinations of interest rate, rent credit, investor contribution and property appreciation rate. They can try different scenarios to find the one that satisfies all.
Second, the spreadsheet provides the accounting record of where the parties stand at any point in time. They can watch their equity shares change over time and can use the simulation capacity to forecast what they will be in the future.
The spreadsheet is a tool, not a contract. To use the tool effectively, the parties should have a contract that addresses four major issues:
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