A home equity agreement allows homeowners to access a lump sum of cash without applying for a traditional loan. In exchange for receiving cash now, the homeowner agrees to repay a percentage of their home’s value at some future date. Home equity agreements are an alternative to home equity loans or lines of credit. While they may appeal to some homeowners, there are important pros and cons to weigh.
Table of Contents
Key Points
• A home equity agreement lets a homeowner get a lump sum of cash in exchange for giving a third-party investor a percentage of the home’s future appreciated value.
• Unlike a loan, a home equity agreement typically requires no monthly payments, just one large lump-sum payment at the end of the term or when the property is sold.
• The major drawback of a home equity agreement is the unpredictable and potentially high cost of repayment, which is tied to the home’s appreciation and can be difficult to budget for.
• Repayment is typically due in a lump sum when the contract ends (at the 10- to 30-year mark) or when the home is sold.
• A home equity loan, home equity line of credit, cash-out refinance, or reverse mortgage (for those 62 and over) are other ways to access home equity with more predictable payments.
What Is a Home Equity Agreement?
A home equity agreement is a contract between a homeowner and a third-party investor, typically a corporation. This contract allows homeowners to tap into cash using their equity, while giving the investor a stake in the home’s future appreciation. Home equity is the difference between what’s owed on the mortgage and your home’s fair market value. These agreements may also be referred to as home equity contracts, shared equity agreements, or home equity investments (HEIs).
What is a home equity agreement designed to do? For homeowners, it’s a way to get cash that they can use to fund home improvements, consolidate debts, or meet other financial needs. Home equity agreements are not traditional home equity loans; that means homeowners do not have to make monthly payments or pay any interest charges on the cash they receive.
For the investor, a home equity agreement is an opportunity to benefit from a property’s appreciation over time. Once the contract period ends, the investor walks away with a predetermined amount of equity. Essentially, it’s similar to any other type of buy-and-hold strategy, in that the investor is banking on their investment gaining value in the long term.
Home equity agreements have become increasingly common in recent years, and it’s important to understand that they can be risky arrangements. While they are often marketed as an alternative to a loan, they do in fact require repayment. The amount of the repayment can be difficult to predict, and when it comes due, it can be in the hundreds of thousands of dollars.
How Home Equity Agreements Work
Home equity agreements work by allowing homeowners to leverage their equity for a set period, with the agreement to give an investor some of the home’s future value. For example, in exchange for $50,000 in cash today, you may agree to repay the investment company that amount, plus 10% of your home’s value in the future. The terms of the contract dictate how the arrangement works, including the length of the contract period, the amount of appreciation the investor gets to collect, and any obligations the homeowner is expected to uphold regarding the property’s maintenance and upkeep.
Requirements and Eligibility
Eligibility requirements for a home equity agreement primarily center on your home’s value and the current amount owed on your mortgage. Home equity agreement companies may take other factors into account as well, including your credit scores, income, and the area in which your home is located. If approved, you’re expected to:
• Continue making regular mortgage payments (if you have a home loan)
• Pay required property taxes promptly
• Maintain adequate homeowners insurance coverage
• Take care of necessary maintenance, repairs, and upkeep
As you think about how a home equity agreement works, it’s important to understand that a typical home equity agreement lasts 10 to 30 years; you won’t pay any equity value to the investor until the contract ends. Should you decide to sell the home before the contract period expires, you would need to pay the required amount to the investor at that time. If you have a home loan, you’ll also be paying off the mortgage at that time.
How much equity do you need for a home equity agreement? Home equity investment companies expect you to have anywhere from 10% to 40% equity. In exchange, you may be able to borrow 25% to 30% of your equity. You can estimate your current equity by subtracting whatever you still owe on your mortgage from your home’s estimated value (find that on a real estate site).
Once you have the dollar amount, you can divide by the home’s estimated value to see your percentage of equity. If you proceed with a home equity agreement, you should expect to undergo a professional appraisal to determine your home’s value, which you’ll likely have to pay for yourself.
Is a Home Equity Agreement a Good Idea?
A home equity agreement may be a good option for homeowners who need cash and have sufficient equity, but don’t want a traditional loan arrangement. However, it’s important to consider what a home equity investment contract may cost. Here are the main home equity agreement pros and cons to know.
Pros
Home equity agreements can offer some significant benefits for homeowners who qualify.
• No monthly payment: Home equity contracts do not require a monthly payment, and you’re not creating any debt.
• Easier to qualify: You don’t necessarily need a great credit score to get a home equity agreement; you simply need sufficient equity.
• Flexibility: Funds from a home equity agreement are delivered in a lump sum; there are no restrictions on how you can use the money.
• Built-in safety: Home equity agreements are structured so that risk is shared between you and the investor; if your home’s value declines instead of increasing, you pay less.
Cons
While home equity agreements can hold appeal for some homeowners, the drawbacks can’t be ignored.
• Unpredictable repayment: The dollar amount you repay to the investor is tied to your home’s appreciation, which can make it difficult to know exactly what the cost will be. A review of complaints to the U.S. Consumer Financial Protection Bureau shows that homeowners felt frustrated or misled by their contracts and surprised by their repayment amounts. Disputes might arise about the appraised value of the home, as well.
• Fees may apply: Even though an HEA is not a loan in the traditional sense, you may be expected to pay closing costs and other fees when signing a contract.
• Higher costs: A home equity agreement could prove more expensive than a home equity loan or home equity line of credit (HELOC) in the long run, depending on the amount you have to repay and the extent of your home’s appreciation.
• Refinancing restrictions Many people with an HEA will also have a mortgage on their home, and the HEA can make it difficult to refinance that loan, should a homeowner wish to do so.
• Forced sale: If you cannot repay the amount due to the investor at the end of the contract period, you may be forced to sell the home to satisfy your side of the agreement.
Who Should Consider a Home Equity Agreement
Home equity agreements aren’t right for everyone, and a home equity loan or HELOC might be a less costly way to tap into your home equity. Those who may consider a home equity investment contract include homeowners who need to access a large sum of cash for home improvements, debt consolidation, or other needs, and who also meet one of these criteria:
• Do not want to take on a home loan because they don’t want to add another payment to their budget
• Cannot qualify for a HELOC or home equity loan, based on their credit scores or debt levels
In either scenario, the homeowner should also feel confident that they understand the terms of the HEA and can repay the amount due when the contract period ends, or when they sell the home, whichever comes first.
If you don’t have any plans to sell, either now or later, then you may want to look for another option. While you may assume you’ll be able to pay the investor their due when the time comes, much can happen between now and then. You don’t want to find yourself in a situation where you’re forced to sell because the clock has run out on your home equity contract.
How to Choose a Home Equity Agreement Company
Finding a reputable home equity agreement company requires some research and planning. Some of the most important considerations to weigh as you compare the options include the amount of equity you may be able to access, eligibility requirements, ongoing homeowner responsibilities if approved, funding speeds, and how contracts are structured.
More specifically, you should understand:
• How long the contract term is
• What percentage of your equity you’re expected to repay
• How risk is shared between yourself and the HEA company in case your home’s value doesn’t rise like you expect it to
• What fees you’ll pay, either upfront or at the end of the contract
It’s especially important to understand how the company calculates its equity share. Some companies use a fixed rate of return, while others use a shared appreciation model. With shared appreciation, you agree to repay the amount of cash you initially access, plus a percentage of your home’s appreciation. A fixed return model, meanwhile, means you pay one flat amount, regardless of how much your home appreciates.
How the HEA company calculates its share of your equity could make a big difference in the amount of profit the company walks away with. Additionally, you should also be aware of whether the company caps the amount you’re expected to repay or offers any downside protection. Both can make a home equity agreement more fair and balanced for you, but not all companies offer these benefits.
Checking reviews on sites like Trustpilot or looking at a company’s Better Business Bureau (BBB) profile can give you an idea of its reputation. You can also search the Consumer Financial Protection Bureau’s complaint database to see if any complaints have been filed against a company you’re thinking of working with.
Alternatives to Home Equity Agreements
Home equity agreements are just one way to access your equity. Depending on your situation, you may also consider a home equity loan or home equity line of credit, cash-out refinancing, or a reverse mortgage to get the money that you need. Each option has pros and cons.
Home Equity Loan
A home equity loan is a second mortgage that’s secured by your home. You can withdraw a portion of your equity in a lump sum and repay the loan over a set term, typically 10 to 30 years. Home equity loans usually have fixed interest rates, so you can easily calculate your cost of borrowing and monthly payment.
You can use a home equity loan for any purpose. The amount you can borrow is tied to your equity, credit scores, income, and debt. You might get a home equity loan with the lender you have your primary mortgage through, or shop around for a loan online.
HELOC
A HELOC is a revolving credit line that’s secured by your home. Instead of providing you with a lump sum, a HELOC works more like a credit card. You can withdraw funds from your credit line as needed during a draw period, which may last up to 10 years. During this time, you may be expected to make interest-only payments.
Once the draw period ends, you enter the repayment period, which may last 5 to 20 years. This is when you’ll make both principal and interest payments. You only pay interest on the amount of your credit line that you use. HELOC rates are typically variable, meaning the rate can go up or down over time, but some lenders offer a fixed-rate option.
Cash-Out Refinancing
Cash-out refinancing replaces your existing mortgage with a new, larger home loan. You get the difference between your old and new loans as cash at closing. A cash-out refinance increases your total mortgage debt, but you still have just one mortgage payment to make each month. You might choose a cash-out refi if you’re interested in withdrawing equity and changing the terms of your home loan at the same time.
Reverse Mortgage
A reverse mortgage or home equity conversion mortgage (HECM) is a special type of equity financing available to homeowners aged 62 and older. With a reverse mortgage, you can withdraw your equity in a lump sum or in a series of payments. You repay nothing monthly; full repayment is only required when you sell the home or no longer use it as a primary residence.
Reverse mortgages have strict eligibility requirements, and they charge interest like traditional home loans. Should you pass away with a reverse mortgage in place, your estate would be responsible for settling the debt. That could put your heirs in the position of having to sell the home if they don’t have other resources to pay.
The Takeaway
Home equity agreements can help owners unlock equity without the traditional home loan process, but it’s helpful to consider all paths available. It’s important to understand home equity agreement pros and cons, including the fact that the payment you would ultimately need to make at the conclusion of your HEA term can be wildly unpredictable. You may find that a home equity loan is a better fit if you prefer predictability with how much you’ll repay. A HELOC or cash-out refinance loan could be other good options. Comparing rates from lenders can give you an idea of what you might pay to borrow.
FAQ
How much does a home equity agreement cost?
The cost of a home equity agreement depends on how your contract is structured. Factors that affect cost include the amount of equity you agree to share, the amount of money you receive, and any fees you’re required to pay at the beginning or end of the contract. Upfront fees are similar to closing costs for a mortgage, and may range from 3% to 5% of the amount you receive.
How is the repayment amount determined in a HEA?
Home equity agreement companies typically use one of two approaches to set repayment terms. They may collect a fixed rate of return, or require homeowners to repay the initial amount they received plus a percentage of their home’s appreciation. HEAs may have repayment caps that set an upper limit on what you’ll repay, or include downside protection that helps you if your home doesn’t appreciate as expected.
How do you pay back a home equity agreement?
Home equity agreements are usually repaid in a lump sum when the contract period ends, or when you sell your home, whichever comes first. If you don’t plan to sell, you’ll need to have cash set aside to cover the amount you’re expected to repay. If you do decide to sell, then you could repay the HEA company from the proceeds of the sale.
How do you get a home equity agreement?
To get a home equity agreement, you’ll need to find an HEA company to work with. You’ll also need to meet eligibility requirements, which usually hinge on how much equity you have in the home. Your credit scores and income may also factor into the approval process.
What states allow home equity agreements?
Every state handles home equity loans and home equity agreements differently. Your options for getting an HEA can depend on where you live and which company you decide to work with. It’s not unusual for HEA companies to only offer equity agreements in certain states.
Photo credit: iStock/Miljan Živković
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