Most homeowners wouldn’t mind being able to tap their homes for cash from time to time. Home equity loans and lines of credit are common ways to do so. But if those don’t work for you, another option exists: a home equity sharing agreement.
Also known as a shared equity agreement or a shared equity finance agreement, it’s an arrangement between multiple parties, typically a homeowner and a professional investor (in fact, “home equity investing” is yet another term for the process). A company provides you with a lump sum in exchange for partial ownership of your home, and/or a share of its future appreciation. You don’t make monthly repayments of principal or interest; instead, you settle up when you sell the home or at the end of a multi-year agreement period (typically between 10 and 30 years).
Home equity sharing agreements are generally best for people whose poor credit or high debt-to-income ratio (DTI) could make qualifying for a traditional loan or line of credit difficult. Here’s how these agreements work, the benefits and drawbacks, and who they are right for.
How does a home equity sharing agreement work?
If you’re considering a shared agreement, here’s how the process generally goes. In some ways, it’s not that different from applying for a home equity loan or any sort of home-secured financing.
- Select a company: It’s possible to enter into a home equity sharing agreement with an individual investor. But home equity investment or sharing companies are becoming increasingly common presences on the lending landscape. Compare different companies before choosing which is right for you: Look into fees, repayment terms, and how their equity-sharing models are structured.
- Prequalify for funding: Once you’ve chosen a company, you can typically prequalify to determine how much you might be able to borrow. Getting this insight can be helpful if you have a predetermined amount that you need.
- Apply for funding: If all looks good with the prequalification, you’ll submit a formal application. Be prepared to provide personal and financial information, verify your identity, and schedule a home appraisal.
- Get funding: The approval time frame for home equity sharing agreements is often fairly short. For instance, you may get approved and funded in a matter of a few days.
- Repay the money: While you won’t be required to make monthly payments, you will need to repay the initial investment, plus any additional agreed-upon percentage of appreciation, at the end of your agreement’s term — generally 10 to 30 years. Or, of course, if you sell your home.
Equity sharing agreements and death or divorce
Generally, the heir(s) have the option of continuing the home equity sharing agreement or concluding it — either by selling the property or paying back the company’s share in some other way. In the case of divorce, the options for shared equity agreements and the marital home are typically the same. The two parties have to agree if they will sell the house and split the proceeds — in community property states, it must be split evenly — or to maintain co-ownership, or if one spouse will buy out the other. If it is sold, the investment firm gets paid out of the proceeds. If one spouse retains it, they retain liability for the agreement. But the particular terms can vary by investment company — it’s the one deciding whether the agreement is assumable or must be concluded. So do pay attention to the fine print in the contract, which should carry provisions in case of death or divorce.
What are the different types of home equity sharing agreements?
There are two common types of shared equity agreements. In both cases, you receive a lump sum from your investor/lender. It’s how they get compensated in return that differs.
Share of appreciation model
With this model, you’re obligated to repay the home equity sharing company your initial loan amount, plus a predetermined percentage of your home’s future appreciation, if any.
Share of home value model
With this model, instead of repaying the original lump sum you receive, you just pay a percentage of the home’s value at sale time. So if your home declines in value, the percentage you’ll pay to the investor will decrease; you could even pay back less than your original loan.
Of course, the investors are well-aware of the risk of pegging returns to future appreciation. Often, they lowball or “risk-adjust” your home’s appraisal value to compensate, so it’ll always seem like the home appreciated to some degree.
What are the pros and cons of home equity sharing agreements?
Pros
- Flexible qualifications: Certain home equity sharing companies have lower credit score requirements than many home equity loan/HELOC lenders. Thus, it may be easier to get funding if you have fair or poor credit (scoring in the 500s). Nor are the income requirements as stringent.
- No monthly payments: You won’t need to make monthly payments like you would with a traditional mortgage.
- No interest: Besides not making monthly payments, you also won’t incur loan interest, since technically you’re receiving an investment in your property, not taking out a loan against it.
- Flexible funding: You can use the funds you receive to pay for anything you like, from home improvements to debt consolidation.
- Doesn’t impact your credit: Unlike traditional loans, a home equity sharing agreement isn’t reported to credit agencies, so it won’t impact your credit score to have one. Some people even use an HEA to pay off other debts and improve their credit.
Cons
- You’ll need to repay a large amount: Equity sharing agreements often have repayment terms ranging from 10 to 30 years — at the end of which, the whole debt comes due. With the share of appreciation model, for example, “The homeowner will have to make a large balloon payment at the end of the agreement term, representing both repayment of the advanced funds and the equity provider’s share of the appreciation in the home’s value,” says Peter Idziak, senior associate at Texas-based law firm Polunsky Beitel Green, which services residential mortgage lenders. “Most homeowners will likely not have the ability to make this payment without selling their home or borrowing from another source.”
- Limited availability: Unlike traditional lenders, of which there are many, your options for home equity sharing are more limited. Available companies often have a smaller lending footprint and may not do business in your state.
- Limited funds: With traditional home equity loans and HELOCs, you can often tap as much as 80 percent of your ownership stake. With many shared equity companies, the loan limit is closer to one-third of your equity. If you’ve been in your home a short time and don’t have much equity built up, you might not be able to borrow much at all.
- Reduces your profit in home sale: If your home’s value increases significantly and you decide to sell, an equity sharing agreement could reduce your total profit from the home sale. Likewise, if your home’s value declines significantly, it could be more difficult to repay the initial funds you received from the home equity sharing company (though, you may only have to pay back a portion, depending on the agreement’s terms).
Where do you get a home equity sharing agreement?
You won’t find home equity sharing agreements through banks or other traditional lenders. They are offered by home equity sharing companies, firms that specialize in this form of real estate investing. Home equity sharing companies are becoming more popular and widespread, however. Among the more well-established are Hometap, Splitero, Unison, Unlock and Point.
As a home equity sharing agreement could be a costly endeavor in the future, it’s wise to compare different companies’ reputations, repayment terms, and the percentages of your home’s appreciation or value they’ll receive. Also look at their up-front fees (many charge you origination fees and home appraisal fees) and risk-adjusted amounts of appraised value.
Can you use the funds from a home equity sharing agreement for anything?
Whether it’s consolidating debt, renovating your home or taking a vacation, homeowners can typically use the funds from home equity sharing agreements for anything. The money’s yours, after all.
However, some exceptions may exist, depending on the investment company. Unlock, for example, sets some conditions for homeowners with a credit score in the 500 – 549 range and a debt-to-income ratio greater than 45 percent. Unlock requires those individuals to use the funds to pay off debt.
“We want to put that customer in the best position to qualify for their next mainstream financial product,” says Michael Micheletti, chief marketing officer at Unlock Technologies. “Maybe rates come down in a year from now and you can do a cash-out refi. Maybe rates come down and you want to just refi generally speaking…We believe we are setting customers up for success by mandating those payoffs.”
How much does a home equity sharing agreement cost?
Home equity sharing agreements include transaction fees, which cover the costs associated with setting up and managing the agreement. They’re generally around 3 to 5 percent or so of the total funding amount: For example, Hometap charges a 3.5 percent fee, while Unlock charges 4.9 percent.
Also, homeowners should expect to pay third-party fees, like the home appraisal and various other administrative expenses (not unlike closing costs). Those expenses are typically deducted from the proceeds from the distributed funds.
After the appraisal, some lenders may also apply a risk adjustment to the home’s value. This figure is what the investor uses to calculate the sum they’ll give you; they also use this figure to calculate your home’s appreciation at payout time. Unison’s adjustment is 5 percent of the home’s starting value, for example. If the home appraises for $300,000, the risk-adjusted value would be $285,000, a $15,000 difference.
This risk adjustment means under the agreement, homeowners may get less value out of their home’s equity than they’d thought, and have to pay out more to the investment company at the agreement’s end.
When does a home equity sharing agreement make sense?
Shared equity agreements aren’t right for everyone. But they can make sense in certain cases, especially for those who are house-poor (possessing a valuable property, but lacking liquid assets). Or, for homeowners who have a decent amount of home equity, but whose credit history, existing debt load or lack of income are barriers to qualifying for traditional home-secured loans, an equity sharing agreement may be worth considering. It may also be an option if you have an unsteady income or a fixed income and can’t afford additional monthly obligations.
However, individuals with good or excellent credit, manageable debt and a stable income may find that a home equity loan, HELOC or even a personal loan is likely a better option.
Always weigh the pros and cons before determining if a home equity sharing agreement is right for your situation. In some cases, these agreements have larger costs than benefits, so it may be a wiser decision to focus on improving your financial profile and seeking out more traditional ways of tapping your home equity.
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