Home Equity Investments Explained | Wealth Management

Most homeowners looking to liquidate equity look to traditional mortgage options such as a cash-out refinance, home equity loan, or HELOC. But there’s another way for customers to tap into the equity in their homes: an equity investment or “equity sharing arrangement.”

With an equity investment, you sell a portion of your future equity and receive a one-time cash payment in return. These agreements can be complex and not every homeowner will qualify. But for those who do, it can be a smart way to access your home’s cash value without taking on a new mortgage payment.

If your client may be interested in an equity arrangement, here’s what you need to know.

What is an equity investment?

An equity investment, also called an “equity sharing arrangement,” is a relatively new financial product that allows you to sell equity in your home in exchange for an upfront cash payment. But it is not a loan and no monthly payments are required. Plus, it doesn’t involve taking on debt or selling your home.

In contrast, most homeowners looking to access their home’s cash value must either refinance their mortgage, take out a second mortgage, or sell the property. In a high interest rate environment, taking out a new home loan may not sound very appealing. And this is where equity sharing agreements come into play.

With this arrangement, you partner with a home equity investment company — like Hometap, Splitero, Unlock, Unison, Point, or Fraction — and get quick cash by selling some of the equity you’ve built up.

How equity agreements work

Home equity investment companies can offer you instant cash in exchange for a stake in your future equity. You’ll often have to pay back the amount you’re given at the end of a set term – plus a percentage of any equity gains you’ve accrued during that time.

An example of an equity investment

Andrew Latham, Certified Financial Planner and Editor of SuperMoney.com, says the way equity investments work can vary a bit from company to company. Here’s an example of how one particular model works:

“Imagine you own a home in California worth $500,000. You have $200,000 in accumulated capital. You are looking for $100,000 in cash from an equity investment company. The company offers you $100,000 for a 25% share of the future appreciation of your home,” says Latham.

He continues, “Let’s say your home goes up in value to $740K over the next 10 years (a decade is a common term for an equity investment). This implies an annual rate of appreciation of around 4%, which is close to the historical average. In this scenario, you would have to pay back the $100,000 investment as well as 25% of your home’s appraised value.

Using this example, that would mean you owe $100,000 plus $60,000 ($240,000 increased home value x 25%).

Two types of equity investments

Equity investing actually comes in two forms: shared equity and shared appreciation. With the former, as you build equity in your home, the equity investor does the same. In the latter, the investor shares only part of the appreciation above a certain starting point.

Equity investment professionals

The main advantage of going into an equity investment is that you can withdraw the equity in the home without going into additional debt, unlike a payoff refi, home equity loan, or HELOC.

“Plus, there are no monthly payments, which is a great plus for homeowners struggling with cash flow,” says Latham. “The amount you have to pay back to the investor will vary depending on how much your property increases in value. If the value of your home falls, so does the amount you have to repay.

Also, with shared appreciation models, you typically have at least 10 years until the investment plus the share of appreciation must be paid off. No monthly or minimum payments need to be made before this term expires. (However, you will have to pay back if you sell or refinance your home early.)

Disadvantages of Equity Investments

On the other hand, you could end up paying the company a high return on the equity you sold if the value of your home increases significantly. If you instead opted for a home equity loan or payday refi with a lower fixed rate, you may have paid less for the equity you liquidated.

“The rate of return that a company can earn on an equity investment will depend on the market in which the home is located, the price at which the equity investor purchased the equity, the relative attractiveness of the home in the market, and the outstanding balance on the home equity loan,” points out Kelly McCann, a Portland-based attorney.

Equity investing can also be complicated to understand.

“In general, most homeowners simply do not have the necessary understanding of securities laws to appreciate the risks they are taking by selling some of the equity in their home,” adds McCann.

Who Should Consider an Equity Investment?

Using your home equity can have great benefits. Maybe you want to consolidate high-interest debt or pay off your student loans. Maybe you’re looking to finance an expensive home improvement project or put a down payment on an investment property. Or you are ready to start a new business venture. Whatever the reason, an equity liquidation can offer a quick cash solution.

Home equity investments can be a good option for homeowners who want to build equity and increase cash flow without going into new debt or having to make monthly payments.

“Equity investments are also attractive to homeowners with high debt-to-income ratios or who do not have excellent credit, as equity investments typically have more lenient eligibility criteria,” continues Latham.

A home equity investment can also provide an option for homeowners who may not qualify for other home equity loans or simply don’t want to take on debt.

“Maybe you’re self-employed or have a variable income. Or maybe you are temporarily unemployed or have unexpected medical expenses. As interest rates and the cost of debt rise, equity investment is becoming particularly attractive to a wide range of home owners as there are no monthly payments or interest,” says Rachel Keohane, vice president of marketing for Boston-based Hometap.

How to qualify for an equity investment

To be eligible for an equity investment, you will need to meet specific criteria.

“With our company [Hometap], for example, we typically only invest in properties where the homeowner has at least a 25% equity interest in their home,” says Keohane. “So if your loan-to-value (LTV) ratio is greater than 75%, Hometap may not be the best fit.”

McCann warns that your mortgage lender may not allow you to enter into an equity sharing agreement, or you may be penalized for doing so.

“Often, the loan documents of a mortgage-backed loan prevent the homeowner from selling some of the equity in their home without suffering adverse consequences,” McCann says.

Do your due diligence before committing to an equity investment agreement. While reviews from financial websites are certainly helpful, user review sites like Trustpilot can help you get a better feel for the real homeowner experience.

“Shop around different equity investment companies, compare several offers before accepting one, and read all the fine print carefully,” advises Latham.

Also, check with your mortgage lender to make sure there are no penalties for entering into an equity agreement, and consider hiring an attorney to review the agreements and documentation.

Alternative options for accessing equity capital

An equity investment or shared equity arrangement isn’t the only choice if you want to access the cash value of your home. If you qualify, you can instead take equity out of your home by:

  • A home equity loan that serves as a secured second mortgage and pays a lump sum at closing;
  • A home equity line of credit (HELOC) that you can draw on and repay as needed;
  • A cash-out refinance, which involves taking out equity while refinancing your primary mortgage loan; and
  • Reverse mortgage if you are 62 or older.

One of these options may better serve your client’s needs without offering a portion of their future equity gains.

Leave a Comment