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If you’ve explored the idea of borrowing against your home equity, you’ve probably heard of a home equity line of credit, or HELOC. You may also have run across the phrase “home equity agreement.” Although HELOC users do sign an agreement with their lender, a HELOC and a home equity agreement are not the same thing. Make sure you understand the difference between a home equity agreement vs. HELOC before you sign on to one or the other.
Key Points
• A Home Equity Agreement (HEA) provides a lump sum in exchange for a share of future home appreciation.
• A Home Equity Line of Credit (HELOC) is a revolving credit line with a draw period, followed by a repayment phase involving monthly payments of principal plus variable interest.
• While HEAs can be accessible to borrowers with low credit scores, their final repayment amounts are highly unpredictable and due all at once.
• HELOCs offer flexible borrowing limits and potential tax deductions for home improvements.
• For borrowers with solid credit scores, traditional options like HELOCs and home equity loans are generally more predictable and cost-effective alternatives to HEAs.
What Is a Home Equity Agreement (HEA)?
It’s helpful to understand what a home equity agreement is when you’re weighing your options for cashing in on your home equity. With an HEA, a homeowner sells a share of future profits in their home to an investor — not through a bank but typically via an investment company. The homeowner gets a lump sum of cash immediately, and the investor gets a portion of the home’s future value, or a portion of the amount that the home value appreciates, depending on the agreement.
Homeowners who enter into an HEA don’t have to make monthly payments on the amount they get from the investor, or pay interest. But when the home equity agreement contract comes to an end (either after a predetermined amount of time or when the home is sold) the homeowner must pay the investor a large sum all at once: the amount originally loaned plus whatever portion of the home’s value has been agreed upon. The amount due is highly unpredictable, because it’s hard to know at the outset of the agreement how much the home will appreciate (or decline in value).
Contracts vary, but what is consistent is that the home will need to be appraised at the outset of the agreement and the investor will have a lien on the home. The contract between the homeowner and investor will spell out when the investor will realize their profit. Sometimes the investor can realize profit when the home reaches a certain value. In this case, if the home appreciates faster than expected, the homeowner may owe a large sum of money sooner than expected.
The homeowner continues to pay all costs associated with the home. So if you renovate the kitchen, you pay for the upgrades in full. That new kitchen will later contribute to the home’s appreciated value, and the investor will benefit from your investment.
What Is a HELOC?
A home equity line of credit (HELOC) is very different from a home equity agreement. With a HELOC, a qualifying homeowner can obtain a line of credit. The homeowner can borrow against the line of credit, as needed, throughout a draw period that can be as long as a decade. During this draw phase, you might only pay interest on the amount borrowed. After the draw period ends, the homeowner begins making monthly payments against the principal, plus interest, for a period of 10 or 20 years.
The interest rate on a HELOC tends to be a variable rate, meaning it can rise and fall with market forces — so the amount you pay on a HELOC might change from month to month.
A HELOC is not to be confused with a home equity loan (sometimes called a HELOAN). Both are a way of borrowing against your home equity, but with a home equity loan you receive a lump sum and immediately begin making monthly payments to repay what you have borrowed, with interest. When you compare HELOANs vs. HELOCs, you’ll see that home equity loans usually have fixed rates, so the monthly payment is consistent and you will know at the outset of the loan the total amount you will spend to repay it.
Recommended: HELOC vs. Home Equity Loan
HEA vs HELOC: Key Differences
This table sums up some of the key differences between a home equity agreement vs. HELOC. One significant difference is that HEAs offer a lump-sum loan, while HELOCs allow borrowers to access funds as needed, up to a predetermined limit.
HELOC vs. HEA at a Glance
| Home Equity Agreement | HELOC | |
|---|---|---|
| Payment type | Upfront lump sum | Line of credit to use as needed |
| Contract required | Yes | Yes |
| Appraisal needed | Yes | Usually; may not require in-person appraiser visit |
| Upfront fees | Possibly | Usually |
| Minimum credit score | 500 or better | 640 for some lenders; 680 for many lenders |
| Charges interest | No | Yes, usually variable rate |
| Repayment structure | Repayment upon sale of home or based on home appreciation or calendar deadline | Repayment phase typically begins after a multi-year draw phase. Monthly payments of principal plus interest |
Pros and Cons of an HEA
As you can see in the home equity agreement vs. HELOC equation, home equity agreements are complex, and there is risk involved in borrowing money this way. These agreements may be more attractive to people with low credit scores, who would otherwise have trouble borrowing against their home equity with a home equity loan or HELOC.
An HEA may be attractive to some borrowers because they think the total cost of borrowing with one will be lower than the cost of borrowing with a HELOC or home equity loan. But it’s hard to predict the total at the outset of an HEA agreement. And both HEAs and HELOCs can have fees.
One big drawback of a home equity agreement is that the investor has a lien on your property, so if you fail to repay the loan as agreed, the investor can force a sale. And if you wish to sell your home, you’ll need to factor the investor’s payout into your decision-making.
If you’re selling your home in a weak market, or it has not appreciated as much as you had hoped before a sale, you might still be required to pay the investor a minimum amount, and this can eat into your profits. If an owner dies with a home equity agreement in place, the heirs may be forced to sell the home to repay the investor.
In a nutshell, the pros and cons of an HEA look like this:
Pros
• Available to borrowers with low credit scores As noted above, it may be possible to get an HEA with a score as low as 500.
• No ongoing monthly payments HEAs don’t charge interest or have installment payments
• No repayment for many years with most agreements (unless home is sold) The length of time that can pass will be determined by a homeowner’s individual agreement.
Cons
• Hard to predict the total cost When payment is based on a home’s appreciated value, the size of the payment can be hard to guess.
• Large payments are due all at once Overall, home equity agreements have higher borrowing costs, and the full amount is due in one lump sum.
• Some agreements force repayment when the home reaches a certain value Whether this applies in a borrower’s case will depend on the agreement; review agreements carefully.
Pros and Cons of a HELOC
HELOCs have some drawbacks too:
• Variable interest rate The rate on your line of credit can rise and fall according to market forces. For some homeowners, this uncertainty is uncomfortable.
• Lien on your home This is the primary risk of a HELOC. If you draw on it and then cannot pay back what you have borrowed, with interest, you risk foreclosure.
• Effect on a home sale Selling your home will likely require you to close out the balance due on your HELOC.
And here are some of the advantages of a HELOC.
• Flexible credit line You can use your HELOC anytime during the draw phase and withdraw as much money as you need, up to the credit limit. That limit can be as high as $750,000, depending on the value of your property and your home loan balance. If you pay back what you have borrowed, you can even draw on the HELOC again.
• More predictable repayment HELOCs have variable interest rates, but the total amount you will spend to borrow money with a HELOC is likely still more predictable than the costs of borrowing with an HEA. Your HELOC agreement will spell out your HELOC’s maximum interest rate, whereas it can be difficult to estimate how much your house might appreciate during the HEA.
• Tax benefits The interest on a HELOC (or a home equity loan) can be deductible on your federal taxes if the money borrowed is used to buy, build, or substantially improve the home that secures the HELOC. Home equity agreements don’t have this tax benefit. (Talk to a tax advisor about how you might claim this deduction.)
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Which Option Is Right for You?
As you consider HEA vs. HELOC pros and cons, you may see that a HELOC can be a smart solution if you need access to funds on an as-needed basis for debt consolidation, or to pay for renovations, medical bills, or other expenses. A home equity agreement is a way to borrow against your equity if you have a weak credit score and can’t qualify for a HELOC. But an HEA delivers a lump sum versus a credit line, and the total cost of an HEA can be hard to predict.
If neither option feels quite right, you might consider other alternatives to a HELOC, such as a cash-out refinance or a home equity loan. With a cash-out refi, borrowers undertake a mortgage refinance for more than they currently owe on their home loan, taking the difference in cash. A mortgage refinance makes sense only if current interest rates are lower than the rate of your existing mortgage. A home equity loan might be a good fit if you like predictable monthly payments and need a large sum all at once.
The Takeaway
For borrowers with a solid credit score, a home equity line of credit (HELOC) can provide flexible access to funds, with an interest-only payment period of up to 10 years that can take the pressure off owners to immediately make payments against the principal. An HEA may sound appealing because it doesn’t charge interest, but the total cost of borrowing with a home equity agreement can be hard to predict, and when it’s time to pay back on an HEA, a large amount is due all at once.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $750,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
Unlock your home’s value with a home equity line of credit from SoFi.
FAQ
Is a home equity agreement a good idea?
For borrowers with solid credit scores, there are often better choices than a home equity agreement (HEA), such as a home equity line of credit. So consider HEA vs. HELOC pros and cons. A home equity agreement doesn’t charge interest like a HELOC, but the ultimate amount a homeowner will pay is unpredictable, and the payment will be due as one large lump sum. Home equity agreements are also typically constructed so that if a home loses value, the HEA investor still gets paid. HEAs are more expensive than other ways of borrowing, and so are often appealing only to borrowers whose low credit scores make them ineligible for home equity loans or lines of credit.
Can you get an HEA with bad credit?
It is often possible to get a home equity agreement with bad credit, as long as you own a significant portion of your home outright.
What happens to an HEA when you sell your home?
The sale of a home typically triggers the payout to the home equity agreement investor. The borrower/homeowner will owe the amount they originally borrowed, plus whatever portion of the home value or home’s appreciation is specified in the contract.
Are there alternatives to an HEA or HELOC?
One popular alternative to a home equity agreement (HEA) or a home equity line of credit (HELOC) is a home equity loan. This is a lump-sum loan that is repaid with monthly payments at a fixed interest rate. Payments begin immediately after the loan is received.
Does a HELOC affect your credit score?
A HELOC can affect your credit score in a few ways. Getting a HELOC can cause a temporary dip in your credit score because the lender will do a hard credit inquiry before approving your loan application. But after that, a HELOC can leave a positive imprint on your credit score if you make your payments as required. It could also have a good impact on your credit utilization and credit mix, both of which are factored into your credit score.
Photo credit: iStock/Milan Markovic
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