First-time homebuyers face an uphill battle in the best of circumstances, but in high-price areas, many have a particularly hard time coming up with a big enough down payment. That’s why some buyers in Washington, San Francisco and Seattle are getting creative.
Some turn to a San Francisco-based company called FirstREX, which began providing equity home financing to buyers in 2013. In the business world, a provider of equity financing typically acquires an ownership stake, the way venture capitalists do when they fund a startup. But FirstREX doesn’t become a part owner of the homes it helps finance. Instead, the company enters into a contract in which the buyer agrees to repay the company’s investment plus as much as 40% of the change in value of the home when it’s sold.
“The return on investment to our investors is based strictly on the performance of the property going forward,” says Michael Lyon, director of sales for FirstREX. “We take no ownership.”
Smaller down payments
In most cases, buyers with a smaller down payment can get a loan backed by the Federal Housing Administration, or FHA. But loan limits for these programs top out at $625,500 for single family homes in pricier metro areas like San Francisco or New York, and less in lower-priced cities and regions.
Banks generally don’t accept funding from outside the buyer’s own resources when it comes to down payments. Lenders often regard the down payment as a measure of the buyer’s ability to repay a mortgage loan, because amassing a down payment takes most people more than a few years of saving, and that requires a certain amount of self-discipline. But a handful of lenders, including Seattle’s HomeStreet Bank, give buyers the option of using FirstREX for down payment assistance.
Jumbo loans, which are above lending limits for most mortgages, almost always require a 20% down payment, according to Christopher Caproni, a loan advisor with RPM Mortgage in Mill Valley, California. The limits for home loans that are generally repackaged and sold to investors are set by Fannie Mae and Freddie Mac, the government-sponsored enterprises that backstop most mortgages in the U.S.
In most cases, FirstREX works with buyers who can muster a down payment of 10% to 12.5% of the purchase price. The company matches the buyer’s down payment. That means the buyer is able to get a loan for 80% of the purchase price or less, avoiding private mortgage insurance, which is usually required when a borrower puts up less than 20%. The insurance protects the lender against a default on the debt.
“A lot of people don’t even know they can buy with 10% of their own funds and avoid mortgage insurance,” Caproni says. “People go from fence-sitting to a yes when they hear about this.”
Buying sooner than expected
Steve Lapin and his wife, Courtney, found that an agreement with FirstREX meant they didn’t need to wait to buy the home they wanted. They were renting a loft apartment that Lapin describes as a “bachelor pad” in San Francisco’s Mission District. But the space had no interior walls, and they were expecting their first child.
“We knew we were growing out of the space,” says Lapin, who works in the financial industry. They looked at two-bedroom rentals, but the places they liked cost astronomical amounts. They found a condo for sale in the city’s Inner Richmond district, but couldn’t qualify for a loan. Their bank expected them to come up with 30% of the purchase price — 20% for a down payment and an additional 10% in reserve funds. Time was tight because they were competing against other potential buyers.
“We had to act within 24 hours,” Lapin says. FirstREX connected the couple to RPM Mortgage and matched their 10% down payment to get the deal done.
“This is a way that a first-time buyer can get into a neighborhood that they couldn’t otherwise get into,” Caproni says.
There are other alternative sources for down payment funds. FHA-backed loans permit down payments as low as 3.5%, although mortgage insurance on such loans can be expensive. Freddie Mac’s HomeSteps program offers buyers a chance to score foreclosed homes for a 5% down payment and no mortgage insurance. There are also assistance grants available from some state and local governments. But many of these programs can’t provide enough cash in high-priced markets, which adds to the appeal of FirstREX for some buyers.
Homeowners make no payments to FirstREX, and no interest is charged on the company’s investment. When the owner decides to sell, the property is appraised and that’s used to determine any gain in value due the company. If the owner has renovated or improved the home in ways that increase its sale price, that added value belongs to the owner.
Some buyers may find it challenging to give up a significant percentage of the gain from a sale. But Lapin says it will be worth it.
“I knew I’d have to give up some of the return” on my investment, he says. “But that’s OK, because their capital allowed me to get a bigger home and get the home I wanted for my family. It seems like a pretty fair trade.”
Limited availability
The availability of FirstREX financing is limited to buyers in three states and Washington, D.C., and no other company offers a similar product, according to Lyon, the FirstREX sales director. Buyers don’t need perfect credit for FirstREX to invest — RPM’s Caproni says a 680 FICO score, which is considered average credit, is the minimum needed for a deal with his firm.
Mortgage-appreciation financing first appeared in the 1970s, according to Bloomberg BusinessWeek, which cited Fannie Mae Foundation research. A company in San Diego, EquityKey, offers an alternative to home equity loans using a similar approach. FirstREX also provides homeowners with a way to cash out some of their equity without taking out a second mortgage or refinancing.
Homeowners can buy out FirstREX before selling by returning the company’s initial investment plus its share of any gain in value, based on a third-party appraisal. But there’s a financial penalty for doing so within the first three years. FirstREX investors prefer to partner with homeowners for the long haul.
“REX’s money comes from pension funds and endowment funds,” says Caproni, who is one of the few mortgage lenders in California that provides loans to buyers who have partnered with FirstREX. “Those asset groups are very patient.”
Lapin, meanwhile, says he’s very happy. He and his wife moved into their new home just 10 days before their son was born.
Virginia C. McGuire is a staff writer covering personal finance for NerdWallet. Follow her on Twitter @vcmcguire and on Google+.
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