John Buyer has targeted a house he wants to purchase at $300,000, planning to put 10% down and finance the remaining 90% with a 30-year fixed-rate mortgage at 4%. His monthly payment would amount to $1289 and mortgage insurance would be $68 a month more. Then a firm named Unison offered him the following deal. Unison would invest $30,000 to bring the total down payment to 20% of property value, reducing the mortgage payment to $1146 and eliminating the mortgage insurance. In exchange for the investment, when the house was sold (or in 30 years, whichever comes first), Unison would get its $30,000 back plus 35% of the appreciation.
When I decided to look into this program, the first thing I did was to ask my colleague Allan Redstone to develop a spreadsheet model of the process. The spreadsheet would allow me to calculate the rate of return that Unison might earn on its investment in the down payment, and it would also indicate whether a borrower doing the deal will be wealthier or poorer 5, 10 or 20 years in the future when he sells the house. While the outcomes depend on critical assumptions regarding price appreciation on the house, the mortgage interest rate, the life of the transaction, and other factors, the general conclusions are unambiguous. Under the terms Unison is now offering, transactions generate an attractive rate of return to Unison as investor, but homebuyers are poorer at the end of the transaction period than if they had not done the deal.
The rate of return depends heavily on house price appreciation and the transaction period. On a transaction that terminates in 5 years, the return with a 3% appreciation rate is 9.4%, with 6% appreciation it is 16.2%, and with 9% appreciation it is 21.9%. The rate of return is smaller over longer transaction periods, but it remains attractive. On transactions terminating after 20 years, the returns with 3%, 6% and 9% appreciation are 6.8%, 11.0% and 14.4%.
From the borrowers’ standpoint, however, it is a bust. I compared the borrower’s net worth with and without the Unison deal for every combination of 3%, 6% and 9% appreciation rates, 4%, 7% and 10% mortgage rates, and 5, 10 and 20-year periods, or 27 combinations in all. In 26 of them, the borrower’s net worth was lower at the end of a transaction if she did the deal. Here is an example using an appreciation rate of 3%, mortgage rate of 4% and period of 5 years.
The house purchased for $300,000 is worth $347,782 5 years later, whether the deal is done or not, but the loan balance is substantially lower with the deal -- the $240,000 loan is paid down to $217,074. Without the deal, the initial loan balance of $270,000 is paid down to $244,208. This puts the deal ahead by $27,134. In addition, the buyer’s payments during the 60 months were $10,529 lower with the deal, for a total benefit of $37,663. However, the borrower has to repay the $30,000 that Unison contributed to the down payment plus 35% of the capital gain of $47,782 or $16,724. The total payment of $46,724 to Unison exceeds the benefit of $37,633, making the deal a loser for the buyer.
The moral of this exercise is not that third party investment in a home purchase is a bad idea, it may be a very good idea but it must be priced as a win/win, not as a win/lose. The repayment of the original investment is particularly troublesome because it is due even if the house doesn’t appreciate, which makes it much more of a loan than an investment. Acknowledgement of this onerous feature is hard to find on the Unison web site, if it is there at all -- I called them to clarify it.
Given the way in which Unison prices its investment, it is not surprising that its web site does not provide any on-site tools that allow users to quantify the costs versus the benefits. A so-called calculator turns out to be a device to put the user in contact with a sales person.
The spreadsheet used in developing this article will appear on my web site in the near future. I will email it to any reader who wants it right away; you can request a copy by emailing me at jguttentag@mtgprofessor.com
