So-called ‘shared-equity’ or ‘co-equity’ arrangements are just one way people can buy a home without a big down payment. : Sharing Equity with Stranger to Buy a Home

If a total stranger hadn’t helped out, Frank and Melody Knauer and their four children would probably still be renting a two-bedroom duplex.

But thanks to the stranger--who forked over $14,000 for a down payment in exchange for a share of their profits when they sell--the Knauers now live in their own three-bedroom home in San Clemente, not far from the ocean.

“The thought of buying a house with somebody we didn’t even know was a little weird, at first,” says Melody.

“But it’s not like we have to live with him--we just needed (his) down payment. And so far, everything has worked out fine.”

So-called “shared-equity” or “co-equity” arrangements are just one way people like the Knauers are buying a home without a big down payment.

The concept isn’t really new. For decades, many young people have depended on their families to lend them--or give them--the down payment to buy their first house.

But with a growing number of older people becoming “house rich but cash poor,” many of today’s parents simply can’t afford such generosity.

Some experts say formal equity-sharing agreements give parents and their offspring the best of both worlds: a chance for the children to own their own home, and an opportunity for everyone involved to make money in real estate.

Equally important, independent investors are finding that equity-sharing deals can provide hefty profits and important tax benefits. Their numbers are expected to grow in the years ahead as skyrocketing home prices make it more and more difficult for young people to purchase their first home.

“I look at equity-sharing as a ‘win-win’ proposition,” says Mark Blakely, president of CoEquity Corp., a Costa Mesa-based firm that packages equity-sharing deals.

“It helps a person or young couple buy a home that they couldn’t otherwise afford, and it gives the investor a solid investment.”

Equity sharing basically means owning a home with somebody else.

In its simplest form, equity-sharing involves two parties: An owner/investor who puts up the down payment for a house but will live somewhere else, and an owner/resident who will stay in the property and make the monthly mortgage payments to the bank that provides the bulk of the financing. Profits are split when the property is sold.

Tax deductions for mortgage interest payments typically are handled in one of two ways. In some cases, the resident pays the entire monthly mortgage payment and gets 100% of the write-offs.

In others, the investor and resident each pays half the mortgage payment and gets 50% of the interest write-offs. The resident also gives a monthly check to the investor, representing “rent” for half the house; this may allow the investor to take additional deductions, such as depreciation for his “rental” property.

The basic equity-sharing agreement can be altered to accommodate each party’s special needs, for example, giving a bigger piece of the resale profits to one of the owners and a bigger share of tax deductions to the other.

But regardless of how an equity-sharing deal is structured, the bottom line is that someone gets to move into a home with little or no money down--and that’s what attracts many would-be home buyers who can’t save up thousands of dollars for a down payment.

“We had thought of everything, but there was just no way we could find $20,000 or $30,000 for a down payment on a home,” says Wendy Rafkin, an academic counselor who was renting a San Pedro townhouse with her husband, Robert, and their two children until last fall. “But then we heard about equity sharing . . . and now we have a house of our own.”

‘Nothing to Lose’

Wendy was skeptical when she first saw a newspaper ad placed by CoEquity: After all, she says, “the thought of someone else putting up the down payment on our home sounded too good to be true.”

But she figured they had nothing to lose, so she scheduled an appointment for her and her husband, a shipyard worker, to discuss their financial situation with a CoEquity representative.

Based on the Rafkins’ yearly income and monthly debt obligations, the representative determined that the couple could purchase a house for as much as $199,250 and afford a monthly payment of $1,877. If they found a home at or below that price, CoEquity would handle all the paper work and supply an investor willing to make the down payment.

Just a few weeks later, the Rafkins found a house they liked--a three-bedroom home with pool in Huntington Beach. A deal was struck to purchase the house for $179,000.

Take Tax Deduction

The investors put up a 10% down payment of $17,900, plus another $5,800 for half the closing costs; the Rafkins paid the other $5,800 in closing costs, which include CoEquity’s service fee. The couple’s total monthly mortgage obligations come to $1,470 and they get to take all the tax deductions for finance charges.

If property prices rise 7% a year--a moderate estimate--the Rafkins’ original $5,800 investment in the property will grow to $62,050 seven years from now, when the agreement expires. The couple can then buy the investors out, raising cash by refinancing or taking out a second mortgage.

If the couple wants to move, the investors can buy the Rafkins out or the property will be put up for sale. The contract dictates how profits will be divided.

“It sounds kind of complicated, but it really isn’t,” says Wendy. “For people who don’t have a down payment, equity-sharing is a great way to go.”

Equity-sharing has become increasingly popular over the past few years as home prices in most parts of the country rose faster than incomes, and lenders required bigger and bigger down payments, says Georgia Anderson, co-author of “Equity Sharing: Profiting from Joint Home Buying.”

Tax Shelter Benefit

The trend is also getting a boost from the landmark Tax Reform Act of 1986, which preserved deductions for mortgage interest payments but limits write-offs for other types of finance charges.

“Owning your own home is about the only tax shelter left, so more people want to own rather than rent,” says Anderson, who has invested in about 30 equity-sharing deals and put together another 300 or so as president of Denver-based Co-Equity Investments Inc.

Investors, she adds, are also becoming more interested in equity sharing: Not only do the deals provide good profit potential, but they can easily be structured to provide tax write-offs that most other investments no longer provide.

Would-be buyers and investors interested in equity sharing often find each other with the help of friends, real estate firms, mortgage brokers and lenders.

They also take out newspaper advertisements, Anderson says. An ad placed by a willing investor might say, “Share in my equity--no down payment required.” An ad by a would-be buyer might say “Investor needed for equity-sharing--I’ll make the monthly payments.”

Getting Credit Report

Investors can usually screen out undesirable partners with the help of credit-reporting agencies and the potential partner’s current and previous landlords and employers, Anderson says.

Of course, any real estate deal should be put in writing. But equity-sharing arrangements require extra considerations. For example, clauses must be added to clarify who will pay the monthly mortgage payments and repair bills, how tax deductions will be split up, when the property will be sold and how a buy-out price will be set.

Provisions should also be made to deal with unexpected events, such as the death of one of the partners, divorce, or a job transfer that forces the owner/resident to move.

Experts say the documents should be drawn up by a real estate broker or lawyer experienced in equity-sharing arrangements. Books on equity sharing often contain sample contracts.

Although most problems can be avoided through proper screening techniques and a clearly defined contract, even the best-laid plans can go awry.

“On paper, equity-sharing looks real good,” says John Gibson, who’s still smarting from a deal in San Jose that went bad nearly two years ago. “But in reality, you’re usually dealing with someone who you don’t really know--and people aren’t always as reliable as your arithmetic.”

The Perfect Candidate

Gibson was introduced to his former partner, an inspector at a Silicon Valley computer company, by Gibson’s accountant. The inspector wanted to buy a house, had a good credit history, but didn’t have a down payment--the perfect candidate for equity sharing.

The two worked out an arrangement calling for Gibson to put up $15,000 toward the purchase of a $110,000 home. The partner put up nothing, but was responsible for paying the $975 monthly mortgage payment to the lender and a modest $50 a month to Gibson as compensation for the interest Gibson could earn if he put the $15,000 into a savings account.

Each took a 50% interest in the property. The two would split the tax benefits until the property was sold, and then they’d split the profits.

Everything went fine for about six months--until the inspector lost his job.

“First the $50 checks stopped coming,” remembers Gibson. “Then the guy quit paying the bank.

“Finally, he just left town.”

To protect his credit rating, Gibson began making the monthly mortgage payments himself. Although he was able to rent out the home for $800, it was $175 a month less than his mortgage payment.

Traced to Atlanta

It took Gibson several months to finally track down his estranged partner; by then, the man was living in Atlanta.

“I could have sued him, but that would have taken maybe $10,000 and there was no guarantee I’d ever collect a dime,” says Gibson. “Unfortunately, he knew that, too.”

With nothing to lose, the inspector drove a hard bargain: He insisted that Gibson pay him $1,000, or he wouldn’t relinquish his 50% interest in the house unless a judge forced him to do so.

“Morally, I didn’t want to give him the money,” says Gibson. “But from a practical standpoint, it was the cheapest and fastest way to cut my losses.”

Gibson finally sold the property last year; after commissions and out-of-pocket expenses, he figures he lost about $9,000. “There’s no way I’d ever get in a deal like that again,” he says emphatically.

Some Are Disappointed

To make walking out less attractive, Anderson says the owner/resident should always be required to put up at least a few thousand dollars, even if it’s simply to pay closing costs. “If he’s got some of his own cash in the home, he’s less likely to walk away,” she says.

But sometimes even people who see a successful shared-equity deal to its conclusion come away a bit disappointed.

“It’s kind of ironic,” says John Gregg, a Glendale-based home builder who invested in several shared-equity deals. “Even if we each made $30,000 from the deal, some buyers would be mad because I ‘took’ half of their profits.

“They never complained when I lost money, or just broke even--and I had a few of those deals, too.”

But as far as Wendy Rafkin is concerned, she’ll be more than happy if she and her husband wind up with a big profit--even if half of it must be shared with strangers.

“Obviously, we’d like to keep all the money for ourselves,” she says. “But the way I see it, 50% of something is better than 100% of nothing.

“If it weren’t for equity sharing, we’d still be renting.”

NEXT WEEK: Finding bargains in foreclosures.