May 11, 2023
Between soaring interest rates and the increasing costs of daily life, homeowners are searching for new and creative ways to access cash and tap their home equity without incurring steep borrowing costs.
Typically, you can get to your equity by applying for a home equity loan, opening a home equity line of credit (HELOC), or doing a cash-out refinance, but these options can come with high interest rates, closing costs, and stringent credit score requirements.
So what’s a cash-strapped homeowner with a shaky credit score to do?
One alternative is a home equity investment (HEI), also referred to as a home equity sharing agreement.
“Home equity investments are typically a good option for homeowners who don’t have great credit or have a high debt-to-income ratio,” says Andrew Latham, a certified financial planner and director of content at SuperMoney.com.
But bear in mind there are some very significant strings attached.
“On the one hand, they can provide homeowners with a way to access their home’s equity without taking on additional debt,” says Latham. “On the other hand, they typically come with high fees, and the investor may take a large portion of the home’s appreciation.”
Here’s what you need to know about home equity investments so you can decide if it’s something you’d like to consider looking into further.
What is a home equity investment?
When you agree to a home equity investment, you’re essentially allowing an investment company to buy a portion of your home equity in exchange for cash. HEIs differ from home equity loans and HELOCs in that you don’t have to make monthly payments or worry about interest rates.
“HEIs are liens—not loans—against a property that allow a homeowner to sell a portion of their home today for cash,” says John Green, CEO and founder of the Dallas-based home investment and financing platform Nada.
For example, if an investment company buys a 15% stake in your home equity and your home is worth $200,000, it would give you a $30,000 lump sum.
When an investment company buys a stake in your home equity, it’ll stipulate how long its stake lasts (typically 10 to 30 years) and—this is key—how much you’ll be required to pay back at the end of the agreement term. In most cases, homeowners will have to pay back the original lump sum plus a percentage of the home’s appreciation over the term of the contract.
If your home appreciates at a significant rate, the payback amount for a home equity investment can be double or even triple the amount the investment company originally gave you. Typically, though, your contract sets a cap on the annual appreciation the investor can earn.
How does the HEI payback work?
This is where HEIs get a bit tricky.
If your home depreciates, so does the value of the investor’s stake. Therefore, you have to pay back only 15% of your home’s value, even if that’s less than the original lump sum.
But if the home appreciates, the value of the investor’s stake goes up, as does the amount you need to pay back.
Let’s look at our example of a home worth $200,000: If your HEI is a 10-year contract and, during that time, your home’s value goes up 3% per year, the house will be worth $268,783 at the end of the contract term. The homeowner will then have to pay back the original investment plus the investor’s 15% stake in your home’s appreciation. That’s $30,000 (original investment) + $10,317 (15% of the home’s appreciation) = $40,317.
“You’ll be required to pay that amount at the end of the contract, either from your savings, by taking out a loan, or from the proceeds of selling the home,” says Heather Petty, a home loan and mortgage specialist at Finder in Reno, NV.
And if you can’t pay back the appreciated amount, investors can force the sale of your home.
Before entering into a contract, make sure your terms include a maximum cap on payback amounts.
“There is usually a formula in place to determine the buyback amount, but it’s always tied to the home appreciation,” says Green. “There are 15% caps, 18% caps, 30% caps, and uncapped HEI agreements, which have drastic impacts on payback amounts down the road.”
Pros of a home equity investment
The most obvious upside of an HEI is getting your hands on cash immediately, even with bad credit. This might be attractive to homeowners who are house-rich but cash-poor with a credit score lower than 620. (That’s the minimum score typically required to qualify for a traditional home equity loan.)
“Typically, that means self-employed borrowers, credit-challenged individuals, and those that have a high debt-to-income ratio,” says Jonathan Rundlett, president of EXIT Mid-Atlantic Realty. “You can get cash and not have any additional monthly obligations like you would with a traditional loan.”
It’s true. HEIs are paid to homeowners in a lump sum at the beginning of the agreement and require full payment at the end of the term. This means no monthly payments and a bit of breathing room for homeowners who might feel like they’re drowning in bills.
Cons of a home equity investment
Taking on an HEI means you’re giving up a percentage of your home’s appreciation to an investor. In doing so, you might actually end up paying more money at the end of the contract than the initial cash investment you received.
“If your property appreciates in value significantly—like we saw during the [COVID-19] pandemic—you may end up paying the company a high rate of return as opposed to the interest that you may have paid with a traditional loan product,” Rundlett says.
Also, your mortgage company might bar you from taking on an HEI or assess penalties for entering this type of agreement.
“If you have a mortgage against the property, the contract may have language that does not allow you to enter into an equity sharing agreement,” says Rundlett. “This may allow [your lender] to use their acceleration clause, which gives them the option to require the entire balance of the loan to be paid off immediately.”
There’s no perfect formula for getting cash fast, especially in this economy. But before committing to an HEI, or signing the dotted line on a home equity loan, speak to a financial planner and think about your long-term financial goals. Then, get a second opinion.