Understanding Home Equity Agreements: A Comprehensive Guide

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What Is a Home Equity Agreement?

Key Takeaways

• Home equity agreements involve selling a portion of your home equity to an investor in exchange for cash.
• The investor will later get its money back plus a portion of any appreciation in the home’s value.
• Advantages of home equity agreements for homeowners include no monthly payments and lower credit requirements.
• Disadvantages of home equity agreements include potential loss of future appreciation and limited control over the property.

A home equity agreement is a contract between a homeowner and an investor in which the investor agrees to pay the homeowner a sum of cash in return for a portion of their home’s equity and the future appreciation on it. The agreement does not require monthly payments, and the investor gets their money back, plus any appreciation, either when the home is sold or within a certain time frame. Here is how these contracts, also called home equity sharing agreements, work for homeowners.

How Does a Home Equity Agreement Work?

Entering into a home equity agreement is a straightforward process. The basic steps are:

1. Find an investor that wants to share in your home equity. These tend to be specialized lending companies.
2. The investor will send out a home appraiser to appraise the home. 
3. Once the appraisal is completed, the investor makes an offer on how much it will pay for a certain portion of your home equity. 
4. If you wish to proceed, you agree to the repayment terms and pay the closing costs.
5. The investor places a lien on your home for the agreement amount and pays you a lump sum.
6. Upon the agreement’s expiration (typically between 10 and 30 years) or the sale of the home, you repay the investor the principal amount plus a portion of any appreciation of the home’s value. 

While home equity agreements and home equity loans are similar in that you receive funds based on a portion of your home equity, they differ in several key ways. These include:

• Home equity agreements don’t require monthly payments. 
• Home equity agreements can be available to homeowners with lower credit scores.
• Home equity agreements don’t accrue interest.
• Home equity agreements may offer less money than a home equity loan.  

Pros and Cons of Home Equity Agreements

Home equity agreements can be a practical option for accessing some of your home equity, but it’s important to review every aspect of the agreement before committing. 

Advantages

• You don’t have to make monthly payments. 
• You don’t pay interest on the principal. 
• You may qualify with a relatively low credit score. 
• There are generally no restrictions on how you can use the funds unless your lender requires some of the cash value to be used for other debts. 

Disadvantages

• You may be required to turn over a larger portion of your equity than you’d prefer to, and you might not qualify for as much money as you would like. 
• You’ll have to make a lump-sum payment at the end of the agreement term or upon the sale of the home. 
• You could end up paying more than you would with a home equity loan if your home appreciates at a quick pace. 
• You have a lien on your home in the amount of money you receive. This means you have limited control over your home because you are sharing its equity with another entity.
• You may not live in a state where a home equity agreement is available. 

Pros

• No monthly payments to make

• Principal doesn’t accrue interest

• May not need a high credit score

• Can use the money for any purpose

Cons

• Might require you to put up more equity than you want to

• Have to repay when you sell if not before

• Could pay a lot if your home appreciates a lot

• Lender will put lien on home

• Not available in every state

How to Qualify for a Home Equity Agreement

Investors will look at a number of factors to determine your eligibility for a home equity agreement. Those include:

Home Value

Some home equity agreement companies will only invest in homes over a certain value. For instance, Point requires a minimum home value of $250,000.

Outstanding Mortgage Balances

How much you owe on your home affects how much equity you have in it. Many lenders require that your equity in the home still be over a certain percentage level after accounting for the home equity agreement. 

Credit Standing 

While some home equity agreement companies have lower minimum credit score requirements than other lenders, having good credit could mean that you qualify for more funds.

Understanding the Terms and Conditions

As mentioned, when you enter a home equity agreement, the lender will place a lien on your home in the amount of the funds you receive. This could affect your ability to sell or even refinance the property. 

The homeowner also pays a variety of closing costs when entering a home equity agreement. They can include an appraisal fee, an origination fee, title insurance, recording fees, and other costs. It’s important to get a full breakdown of these costs in order to understand how much you’ll have to pay. 

In addition, the terms outline how much you will have to pay when settling the agreement. If your home has increased in value, this could be a hefty sum. For instance, Unison’s standard home equity agreement typically requires you to repay the initial amount plus a percentage of your equity equal to four times the percentage it invested. So, if you receive an investment of 10% of your home equity, you’ll have to repay that original 10% plus 40% of any home appreciation. For example, if your home appreciates $100,000 by the time you repay, you’ll have to pay an additional $40,000.

Many home equity agreements do not include a prepayment penalty. This is something to look for because it will save you money if you decide to repay the investor before the end of the contract’s term.

Where to Get a Home Equity Agreement

There are several companies that specialize in home equity agreements. If this is an option you are considering, it’s important to check out each one and compare their offers. Here are four, in alphabetical order:

Hometap 

Available in 15 states, Hometap offers investment amounts of up to $600,000 in a home equity agreement. However, it has one of the shortest agreement terms: 10 years, meaning you won’t have long to repay the investment. The company also charges an upfront fee of 3.5% of the investment amount.

Point 

To get a home equity agreement through Point, you’ll need a minimum credit score of 500 and a minimum home value of $250,000. In addition, you’ll need to have a substantial amount of home equity so that you still have at least 30% equity in the home after the home equity agreement. Point does have a lengthy settlement term for its home equity agreements: 30 years. With Point, you could qualify for $25,000 to $500,000. The company charges up to 3.9% as a processing fee.

Unison 

Available in 29 states and Washington, D.C., Unison offers home equity agreements with up to a 30-year term. The company does have stricter qualification requirements than some others, including a minimum credit score of 620. Unison funds investments between $30,000 and $500,000, up to a maximum of 15% of the home’s value. The company also charges a 3.9% transaction fee on every agreement.

Unlock 

Offering investments between $30,000 and $500,000, Unlock provides home equity agreements to homeowners with a minimum credit score of 500. It charges an origination fee of up to 4.9%, and all agreement terms are 10 years. Also, homes must have a minimum value of $175,000 and a maximum value of $3 million. Unlock is available to homeowners in 14 states.

Alternatives to Home Equity Agreements

A home equity agreement is just one of several financing options that allow you to take advantage of your home equity. Alternatives include:

Home Equity Loans

A home equity loan provides a lump sum of money using your home equity as collateral. These loans typically have a fixed interest rate and require monthly payments for a set period of time. You’ll also pay closing costs that include points, fees, and other charges.

Home Equity Lines of Credit (HELOCs)

A home equity line of credit (HELOC) is a revolving line of credit that works much like a credit card. Using your home as collateral, the lender approves you for a maximum amount you can borrow. A HELOC usually has a variable interest rate, but you pay interest only on what you borrow, not the maximum amount you can borrow. HELOCs typically have a draw period, during which you may be required to make interest-only monthly payments or payments that include interest and a small portion of the principal. Once the draw period ends, you will enter the repayment period and have to repay the principal on a schedule set by the lender.

Reverse Mortgages

A reverse mortgage can allow homeowners 62 and older to borrow money against the equity in their home. It doesn’t need to be paid back until the homeowner sells the home, moves out, or dies. The most common reverse mortgage is the government-backed home equity conversion mortgage (HECM).

How Much Does a Home Equity Agreement Cost?

The cost of a home equity agreement can differ from one lender to another. You will have to pay closing costs at the beginning and a portion of your home’s appreciation upon termination of the agreement. That amount could vary greatly based on how much your home value appreciates and the percentage you have agreed to pay the investor. 

Are There Fees Associated With Home Equity Agreements?

Yes, there are several fees you’ll have to pay when entering into a home equity agreement. These include an appraisal fee, origination fee, title insurance, recording fees, and other costs. Ask the home equity agreement company for a complete list before you commit so you know what you’re getting into. 

In Which States Can You Get a Home Equity Agreement?

Home equity agreements are not available in all 50 states. Currently, close to 30 states and the District of Columbia license one or more of the companies that offer them to do business there.  

Can You Use the Funds From a Home Equity Agreement for Anything?

There are generally no restrictions on how you can use the money you receive from a home equity agreement Depending on the homeowner’s financial situation, a HEA provider may require that some of the cash value received be used to repay other debts. 

The Bottom Line 

A home equity agreement could provide access to some of your home equity without making monthly payments or having to sell the home anytime soon. The investor is betting that your home’s value will appreciate at a good pace, and you are, in effect, cutting them in on that appreciation. But a home equity agreement can also be expensive for homeowners and there are other financial products that are worth careful consideration before you decide.

Read the original article on Investopedia.