As homeownership continues to elude many millennials, a novel form of aid has started to gain traction in Canada’s real estate market: shared equity mortgages.
The concept is exactly what it sounds like. Another buyer — typically a company — helps shoulder the cost of buying a home by contributing money to the non-mortgage part of the purchase: the down payment. In exchange, that buyer shares in the home’s equity.
Shared equity mortgages are being pitched as a solution to a problem that has persisted over the past decade amid soaring home prices, high living costs and the absence of stable, well-paying jobs, particularly for young people: it’s become harder, if not outright impossible, to save enough money to buy a home.
Even Canada’s federal government has stepped in. In March, as part of their 2019 budget, the Liberals introduced the First-Time Home Buyer Incentive (FTHBI), which will see the Canadian Mortgage and Housing Corporation (CMHC) provide homebuyers of a certain income level with 10% of the cost of a newly constructed home, or 5% of the cost of an existing home in exchange for an equity stake.
No monthly payments are required, but once the homeowner sells the home, they’re obligated to repay the incentive to CMHC.
Shared equity mortgages aren’t a new idea. Lendl, for instance, is an example of a private Canadian company that plans to enter the space. The Toronto-based startup markets itself as a “helping hand” in an increasingly unaffordable housing market. Contrary to what its name suggests, Lendl is not a mortgage lender. But, just like the government, it’s offering to provide down payment support in exchange for equity in your home.
In a country where a down payment can cost the average wage earner decades’ worth of savings, the concept of shared equity mortgages is increasingly being touted as an innovative and workable solution to the housing affordability crisis. But how exactly does this model work? And is it even a good choice for consumers?
A look at shared equity mortgages
Lendl markets itself as being a service for millennials, by millennials — the three co-founders of the company are all 25 years old.
On paper, the company’s premise is simple: it will give you up to half of a 20% down payment and in exchange, you’ll provide Lendl with 30% of your home’s appreciation value. That 30% is collected either when you decide to sell your home or whenever you want to buy out your share from the company.
Unlike the FTHBI, which only asks that its original investment be returned when the homeowner sells, Lendl wants its money back on the 10-year anniversary of the home purchase — whether you sell at that point or not.
The company’s goal is to help first-time homebuyers enter an almost-impossible market and start building financial stability. To make that possible, it helps customers achieve a 20% down payment, something that can cost hundreds of thousands of dollars in Vancouver and Toronto — the markets that Lendl plans to service first before hopefully bringing its business nation-wide in the future. And because the Canadian government requires a minimum down payment of 20% of a home’s purchase price to avoid having to buy mortgage insurance, it’s a number that most buyers are eager to meet.
Let’s say you’re looking to buy a home that’s valued at $1 million. A 20% down payment would total $200,000. Lendl would give you up to half of that amount — in other words, a maximum of $100,000.
Lendl stresses that its down payment contribution is not a loan — clients won’t face interest or monthly payments. Instead, the company frames its contribution as an investment. On the 10-year anniversary of your home purchase, you’ll give Lendl back its original contribution — as well as 30% of the appreciation value. If your home depreciates, Lendl says it will share in that loss with you.
To clarify how this works, let’s draw again on the example of the $1 million home: if, in 10 years, your home appreciates $100,000 in value, making the total market value of your home $1.1 million, Lendl would take 30% of the appreciation amount — so, 30% of $100,000, or $30,000. Add that to the original $100,000 that the company invested, and the total you owe adds up to $130,000.
Lendl figures it will get its money back in one of two ways: the homeowners sell and give Lendl 30% of the profit, or they spend the decade saving enough money to buy out Lendl’s share. (Homeowners are also welcome to buy out Lendl’s share before the 10-year mark, as long as they wait a minimum of three years after the purchase date.) While the amount of money that Lendl contributes to your down payment can vary, the percentage of the appreciation they can claim is fixed: whether the company gives you $100,000 or $30,000, you’ll always owe them that 30%, plus their original down payment contribution.
Like so many financial services that want millennials as their clients these days, Lendl has no brick and mortar office. To apply for a down payment contribution, you submit an online application. Lendl’s profitability relies on your home appreciating in value, so it won’t invest in just any home — the company evaluates the selection of homes you’re interested in, and will only agree to take you on as a client if it believes your choice — and their investment — is sound.
The second stage of the application process considers the qualifications of the client. While Lendl does not technically issue loans, the company still needs to evaluate applicants the way lenders do, since an applicant’s ability to complete their home purchase hinges on whether or not they can secure a mortgage. Plus, the money they’re giving customers is largely coming from outside investors like institutional investors, endowments and pension funds.
Because Lendl is still pre-launch, several aspects of the business remain in flux. For instance, since March, Lendl has changed its equity stake twice: first from 30% to 35%, and then back down to 30%. It’s hard to say what, exactly, the terms of Lendl’s business will look like if/when the company launches.
A millennial brand for a millennial problem
“I said, ‘I don’t know, this is kind of crazy — this wouldn’t make sense,’” recalls co-founder Alessandro Manca, of the moment several months ago when he says he first came up with the idea.
But he later revisited the idea with a friend, who was enthusiastic. “The more we started dissecting it, the more we felt this was actually a pretty good concept in the sense that... it actually had value to people. We’re actually helping people, and the biggest thing is, we’re in it with you.”
Lendl advertises mainly on social media, and pays influencers to post about the company in their Instagram stories. This digital-first approach is critical to reaching their target demographic, which is increasingly pursuing financial services through apps and websites.
Notable, too, is the company’s aesthetic, which is defined by the same pastel-colour palette and bold graphics used by well-known millennial-facing companies like Wealthsimple, Casper and Everlane. It’s an aesthetic that’s come to be associated with a certain type of company: one whose products are upscale, hip and ethically wrought, yet also affordable. It’s made to appeal, in other words, to people who are simultaneously cash-poor and aspirational.
“Millennials today, including us — nobody really believes in being house poor anymore,” Manca says.
The motivation behind founding Lendl was to give millennial homebuyers a boost in the face of financial obstacles like student debt, high living costs and the growing ubiquity of unstable contract employment. If building home equity is the best way to achieve financial security, why shouldn’t people his age have the chance to do it, too — especially since many millennials actually do make enough money to service a mortgage — if not for a down payment?
“In the time it takes you to save up for a down payment,” he says, “you could have been building equity all along.”
Not the first, and not the last
Shared equity mortgages are already a part of the Canadian housing landscape. In the same budget that introduces the FTHBI, the government acknowledges that such a model is already being offered by non-profit and other providers in Canada; one example is Options for Homes, a condo developer in Toronto that offers a shared equity option to buyers who want to buy an Options unit. (CMHC is actually listed as a partner on the Options website.) For-profit models are more common south of the border, where some have become quite large.
Unison is a San Francisco-based home ownership investment company. Founded in 2004, the company boasts two shared-equity offerings: Unison HomeOwner, which has existed since the company’s launch, and Unison HomeBuyer, which was created in 2013. The HomeOwner program pays homeowners up to 20% of their home’s value, for a 35% share in its change of value at the time it’s sold. The HomeBuyer program, on the other hand, more closely resembles Lendl’s model: homebuyers receive up to 20% of their down payment in exchange for 35% of its change in value.
That means, like Lendl, if your house appreciates, Unison takes 35% of the appreciation value. And if it depreciates, Unison loses with you and all you owe the company is its original investment. (In both options, homeowners can buy Unison out after three years).
One of the biggest differences between Lendl and Unison, however, is when they want their money back: Lendl requires clients to return their investment at the 10-year mark, whereas Unison’s clients aren’t required to do the same until 30 years after the investment is made, or when they sell their home — whichever comes first.
When we ask Manca if he was aware of Unison, he says he knew that the shared equity model already existed in the States, but neither he nor Lendl’s other co-founders followed Unison closely enough “to mimic whatever they were doing.” Conversely, knowing that another company had succeeded using the same model was encouraging.
“There’s obviously a market for this, and it’s helping a lot of people, and it worked out,” Manca says.
After the federal government introduced the FTHBI, Manca told LowestRates.ca in an email that Lendl has received “increased interest, further validating our concept and timing in relation to this issue.”
Affordability and profitability
If housing affordability is the issue that the shared equity mortgage model is trying to solve, then it’s necessary to ask: is it the right solution?
When the federal government first unveiled the FTHBI, some commentators lauded its potential to help young homebuyers — especially if they lived in the country’s less expensive housing markets.
But others were not so sure that shared equity was the most productive move.
The FTHBI has been criticized for being unable to address the root of the problem: housing affordability. It’s not making home prices cheaper and it’s not fixing a housing market that’s gone off the rails.
The initiative is also unlikely to help homebuyers in Vancouver and Toronto, since it’s only available to households with incomes of less than $120,000, and for home purchases up to four times their income, up to a maximum of $505,000. Given that these two cities have the most expensive housing markets in the country — in Toronto, the average price of a home in February was $780,397; in Vancouver, it was $1,016,600 — it’s unlikely that local homebuyers will be able to easily find a home that costs less than $505,000. It’s in these expensive cities where Lendl will have the most advantage over the FTHBI: because the company has no cap on how much their clients’ purchases can cost, buyers can use the company’s services for more expensive homes.
There’s also criticism that the shared mortgage equity model is somewhat predatory, with its target customers being lower-income young people who can’t afford a mortgage at all.
Shared equity mortgage companies, says Nalie Nguyen, broker and executive director at Dash Mortgage, “...might be targeting those who don’t have good credit or not making enough income to qualify with the traditional lenders or insurers. It sounds like they’re somewhat taking advantage of their situation.”
For Lendl, Manca’s description of his target client suggests otherwise. In order for Lendl’s investment to be sound, he says, clients have to be stable enough to qualify for a mortgage and pay off their home purchase. On the one hand, Lendl is branded as a service for young homebuyers who would not have the means to buy without the company’s help. On the other hand, Lendl will only take on clients who make enough money to secure a mortgage.
Manca puts it this way: Lendl’s target customer is someone who can technically afford to service a mortgage, but doesn’t want to wait years to save enough for a down payment.
“Just think about this for a second,” he says. “You need to buy a million-dollar home. And you need to save up $200,000 to put on a down payment in order to apply for an 80% conventional mortgage… Speaking of the average millennial today, living in Toronto — by the time you’ve saved up that $200,000, that million-dollar home could be worth 1.1 or 1.2 million dollars, which now means your down payment is still falling short again.”
“You’re almost chasing a tail you’re never going to catch.”
Beyond the question of whether a shared equity model could help homebuyers, though, there’s the question of whether companies offering these services would even benefit themselves.
“A few years ago, house values always appreciated,” says Nguyen. “But in the last few years, the market has changed, and property values actually are more likely to depreciate.” Nguyen points to a client of hers in Alberta, whose home depreciated almost $200,000 in just a year-and-a-half.
“Three years ago, the Ontario market was so hot. You could buy a house and the next year gain double the value,” says Nguyen. Now, it’s more of a gamble.
Do lenders like the idea of shared equity?
It’s hard to imagine lenders will be wary of approving a mortgage like the FTHBI, which is backed by the government, but what about when some of the down payment source (and equity) belongs to a private company?
LowestRates.ca reached out to all Big Five banks, but none agreed to comment on the potential implications of private shared equity companies entering Canada.
A spokesperson for the Office of the Superintendent of Financial Institutions (OSFI), the federal regulator of the country’s banks, noted that while banks are free to use their discretion when it comes to which clients they choose to take on, they are still expected “to have appropriate controls in place to mitigate the risks they take.”
Still, it’s possible that the shared equity model could present issues for mortgage applicants.
Secured lenders are regulated financial institutions, which means they’re subject to regulatory checks and balances. For instance, lenders need to do anti-money laundering checks to ensure that no part of a homebuyer’s down payment source is laundered. Getting your down payment from a source like Lendl, where there’s a chain of people attached to that down payment and home equity (investor → Lendl → homebuyer → secured lender), would add a whole other layer to this process and likely prolong and complicate your mortgage application.
Thought also has to be given to the title of the home. If a shared equity mortgage company wants a stake in your home, they’re going to need to be listed on the title, too. It’s not unusual for a company to be listed on a title, because some people who own small businesses will run their mortgage through their business. But what about when it’s not your company?
Nguyen says having two names on the title could create a hiccup in the mortgage approval process, especially if one of those names is a company.
“How can we add a company on there as a lender or as a co-borrower?” Nguyen asks. “I don’t think any A lenders would do this. Things could change because they see the market for it… but at this point no traditional lender would be up for this,” she says. “So that could be an obstacle for people going this route.”
The bigger issue has to do with one very important question: what happens if the homeowner defaults? Mortgage lending largely relies on lenders knowing that they have some form of collateral in the event of someone defaulting on their mortgage. That’s usually the home itself. If people’s mortgage payments go into arrears, the lender can foreclose on the house. But in a shared equity mortgage situation — especially with a private company, things like foreclosure and collateral become murky.
Who really owns the house? And in the event of default, who gets to foreclose?
While Lendl will vet clients to ensure that they’re financially sound, in the case that a client defaults on their mortgage, the mortgage lender would likely have first dibs on the property.
“Basically, if somebody were to default on their mortgage, no matter what, the bank is always in first position,” says Manca. “Let’s say you default on your mortgage. The next step is, you’ve got to put your home up for sale, right? You’ve got to pay it off… whatever the outstanding balance is on the mortgage, you pay that back to the bank first.”
He adds, “We would be in second position to [collect] proceeds from that sale, that are owed based on the respective amount that we agreed on at the beginning of the deal.”
Manca emphasizes, though, that because the company is still pre-launch, these terms are subject to change. “We’re ironing out a lot of these finer details right now, just to make sure it’s always fair and makes sense for the homeowner,” he says.
A solution with many questions remaining
So, is the shared equity model actually a smart choice for young homebuyers?
The answer depends. In a scenario where your home will likely appreciate in value within a short time frame, and the appreciation value ends up exceeding what you owe the investor, you could make a profit.
“Maybe this is good for those in Ontario or B.C. where houses appreciate quite a bit and it’s an investment,” says Nguyen. “Or maybe it’s good for those who are flipping houses or buying fixer uppers.”
However, the housing market is not predictable. If prices fall or if you’re not planning on doing anything to increase a house’s market value (e.g., renovations), then a shared equity mortgage may not be a good route, strategically speaking: if you take an investment from Lendl, for instance, would you realistically be able to save enough money to repay the company within 10 years?
This is an especially important question for people to ask themselves if they would rather continue living in their homes after the 10-year mark, rather than sell it. If you’re not selling, you’d have to repay the company out of pocket.
“For people who want to buy for themselves to live in for a long time, most likely this is not a good deal,” says Nguyen.
Still, it might be too soon to tell how the growing popularity of shared equity mortgages will impact Canadians. In terms of how a private model would measure up to the FTHBI, says David Macdonald, senior economist at the Canadian Centre for Policy Alternatives, “there really isn’t any actual data on how the CMHC version would be implemented so it’s difficult to say how it compares.”
The same uncertainty can be applied to Lendl, which is still in the process of firming up its terms.
Nonetheless, there are some who think that shared equity has its benefits — especially if you look beyond individual consumers and consider the economy at large.
“There was a book called The House of Debt written by two University of Chicago economists,” Macdonald told LowestRates.ca in an email. “One of its conclusions is that we should force lenders into taking equity stakes in housing as a means of keeping them honest in their lending (as they’ve got skin in the game), but also of limiting the broader economic hit if housing prices fall.”
“If I were a betting man,” he adds, “I'd say that this equity stake idea came from this book.”