What are the advantages and disadvantages of home equity agreements? Read on to learn about the benefits and potential pitfalls of this option
Updated for accuracy and relevancy on November 29th, 2023
As we’ve discussed in previous articles, there are many ways for a qualifying homeowner to tap into their home equity to build wealth –– whether it’s to tackle some much-needed renovations, pay off high-interest debts, finance large purchases, or simply free up some spending cash. Home equity loans and home equity line of credit (HELOC) are two common options, though credit and equity requirements can be limiting factors for some homeowners. When considering a HELOC vs. home equity loan, it’s important to know that both pathways also require prompt repayment; one extra bill is likely the last thing many cash-strapped homeowners are looking for.
Enter: The home equity agreement (also known as a shared equity agreement), a tool for the homeowner to access a portion of their home equity by allowing lenders to invest directly in the home. In exchange for a partial ownership stake, homeowners receive a chunk of equity from the investor in question, in exchange for a percentage of the future home value. With the housing markets in certain parts of the country showing no signs of slowing, betting on that value seeing a boost can appear far safer than a trip around the roulette wheel –– for lenders, at least.
For those who may be rebuilding their credit (HELOCs and home equity loans require a minimum credit score of 620) or prefer to avoid taking on potentially high-interest debt, a home equity agreement may be the better option. But before you make up your mind, let’s take a closer look at how it all works.
Before an outside party makes the decision to invest in your real estate property, they’ll want to know what their investment is worth –– and what a potential payout might look like. So, the shared equity agreement process will start with a home appraisal to determine the current home’s value. Are you familiar with how to calculate home equity?
In this scenario, let's say you own a home that is currently worth $500,000 and you have an outstanding mortgage balance of $200,000. This means you have $300,000 in home equity, and a shared equity agreement allows you to free up a percentage of this equity. Fairly simple math, sure, but with this financial tool it gets a bit more complex. See, when you enter into a home equity agreement with a lender or investor, you’re tapping into your home equity without signing on for a high-interest loan.
And in place of this interest, you agree to pay the lender a percentage of your home’s increase in value at the end of the equity sharing agreement term. If the home value decreases over this timespan, the amount you might owe will be reduced –– but so will your overall home equity.1,2 But if your home’s value skyrockets (like it might have in the last few years), you can end up owing a lender a tidy sum.
Ending a Home Equity Agreement (HEA) before its term is possible by either repurchasing the provider's equity or selling the property. Should you opt to terminate the agreement early, buying out the provider's equity entirely is one avenue available. However, if immediate full payment isn't feasible, there's often the option to purchase portions of the agreement gradually over time. This gradual buyback approach allows for flexibility, enabling individuals to manage the buyout in stages if immediate full repayment isn't financially viable. Whether through a lump-sum payment or staggered buybacks, terminating the HEA provides an exit strategy that accommodates different financial circumstances, ensuring a means to end the agreement before its intended duration. The fee for paying off a HELOC early can differ from one lender to another, usually staying within a range of a few hundred dollars. This fee might be a set amount or a percentage of the remaining balance, capped at a specific maximum limit.
At the end of the agreement term, typically between 10 and 30 years2, or when you decide to sell the home, you’re obligated to pay the lender back the home equity you “borrowed” in addition to this increase in value. Until And until you pay them back, the lender technically owns a portion of your home. No, they can’t move their things in and start hogging all the hot water. But if the mere idea of someone other than you and your household owning a portion of your home rubs you the wrong way, a homeshared equity agreement might not be right for you.
Whether a shared equity agreement is worth it depends entirely on your individual financial circumstances and goals. Below are some of the pros and cons to consider when deciding whether a home equity agreement is right for you:
Overall, shared equity agreements can be a solid option for homeowners who are looking for a way to access cash without having to sell their homes or take on additional debt, but this cash can come at a hefty price. Therefore, it’s important to carefully consider the costs and benefits of any home equity agreement and to seek the advice of a financial or legal professional before signing on the dotted line.
1. Consumer Affairs. What is a home equity sharing agreement? https://www.consumeraffairs.com/finance/what-is-a-home-equity-sharing-agreement.html
2. Nerdwallet. What Is a Home Equity Sharing Agreement? https://www.nerdwallet.com/article/mortgages/shared-appreciation-home-equity
3. How a HEA Works: Home Equity Agreements Made Easy https://www.unlock.com/blog/home-equity/how-a-hea-works-home-equity-agreements-made-easy/
Chat with a real person & get an offer for your home within 48 hours.Call (314) 353-9757