Tom Kelly: Options to finance your holiday present – a second home

If your New Year’s gift to yourself is to begin the research on the purchase of a second home, here a couple of creative options that might not be on your radar screen.

Remember when you went to camp and you had to have a partner for swimming, hiking and cleanup? Take that buddy system concept and apply it to purchasing a cabin with people you trust and enjoy. Having two or more families, couples or individuals combine their assets and purchase the property as partners makes sense, especially for couples that enjoy being together yet know they will never be able to afford a getaway of their own.

And the often neglected and underestimated factor in second-home purchase is time. People who buy a second home and retain a primary residence often do not spend as much time in the second home as they had hoped. And when a block of time surprisingly surfaces, owners often find themselves traveling to a place they have never been or using the time for a family reunion. But with the buddy system, multiple owners can share the time as well as the costs.

Here’s how the buddy system works. Let’s say the Waters and the Carrs are sailing buddies. Nancy Waters would love a place in San Diego – an escape from Northwest winters – but she and her husband Steve do not have the cash to buy a condo outright and can’t handle the monthly drag of an extra mortgage payment. But Nancy does have some cash she inherited from her grandmother.

One day, while playing golf with David and Pat Carr, Pat discloses that her father is selling a small cottage near San Diego’s Mission Bay with great access to a boat launch for their Hobie Cats. The couple could get a bargain price from the father but do not have the cash for a down payment. David’s new job, however, gives them a comfortable monthly cash flow.

Nancy shares that she is longing for a place in San Diego but even though she has a small inheritance to invest, she and Steve can’t swing another mortgage payment.

Bingo! A deal is struck whereby the Waters would make the down payment and the Carrs would make the monthly payments plus pay for all fees for three years. After three years, they agree to the option to refinance or sell the cottage. The Waters would get their down payment back with a minimal interest allowance, and the two couples would split any appreciation upon sale.

No buddy? Take a peek at equity sharing

The partner process also works with investment property and sometimes is known as “equity sharing.” With investment property, a cash-poor buyer who knows of a good investment often seeks a partner to “front” the down payment. The two form a partnership to share the profits of the sale.

Generally, there are three principals involved in an equity-sharing agreement in an owner-occupied situation – a lender, an investor and a purchaser. The investor negotiates and secures a loan from the lender, puts up the money for the down payment and buys the property. The purchaser (with little upfront cash) then buys an equal share of the property from the investor.

The purchaser lives on the property, maintains it and makes the monthly payments. Both investor and purchaser share major repair bills, depending upon the agreement and who is occupying (purchaser or renter) the home.

The investor often makes about 50 percent on his initial investment plus tax deductions on mortgage interest and depreciation. The buyer gets into a home for little upfront cash, while enjoying part of those tax benefits and the chance to establish credit.

The part of the deal that’s probably the most misunderstood is the ownership split. The purchaser does not automatically get a 50 percent stake in the property. Terms will vary upon the agreement between the investor and purchaser. Those two parties then share in the profits from the increase in equity over a predetermined period of time, normally five to seven years. Typically, the purchaser gets 50 percent of the increase in equity over a specified period of time.

If you are considering equity sharing, ask a lot of questions and have an attorney review all documents. The concept is a legitimate way of buying and selling real estate, but be sure all terms are explained. Check into any investor’s background and don’t be pressured into signing an agreement until you clearly understand the process.