Best Home Equity Investments | February 2023
Are you considering a home equity investment (aka shared equity agreement)? Here’s everything you need to know about how home equity investments work.
Home equity investments are an attractive option for people who either don't qualify for traditional home equity financing or want to tap into their home equity without getting into debt. Here is our list of the top-rated shared equity agreements.
A Complete Guide to Shared Equity Agreements
A shared equity finance agreement involves giving an investment company partial ownership of your property in exchange for funding. In some cases, they can be a smart way to tap into your home's equity without getting further into debt. However, they are not for everyone. Here's all you need to know about shared equity agreements.
What is an home equity investments?
Home equity investments, sometimes known as shared equity agreements, enable a home buyer or homeowner to share home equity in exchange for a one-time cash payment from an investor. Such agreements allow you to liquidate part of your home equity for cash or sometimes are used in the home purchasing process to help prospective homeowners with a down payment.
Investors give homeowners a lump sum in exchange for a share in the future value of their homes. When the homes are sold (or when the contract term ends), the investors receive their share from the sale. If the value of the house increases, so does the amount the investor receives. If the house drops in value, the investor also shares in the loss.
There are no interest rates or monthly payments to worry about. The homeowner doesn't pay off the investor with monthly payments or interest. Instead, at the end of the contract, the homeowner agrees to pay the investor's initial investment and a fixed percentage of the change in home value. In a few cases, the investor's share is based off the overall value of the property at sale.
The end of the contract is set for a predetermined date (terms are typically 10 to 30 years), or when the home is sold. You can buy out the investment at any time.
Shared equity appreciation agreements give investors a low-risk way to invest in real estate that can also offer them tax benefits. There are a growing number of reputable firms offering these products to consumers. Generally, these firms are partnered with large institutional investors, such as pension funds, who are looking for investment exposure to real estate assets.
How sharing equity affects homeownership
A shared appreciation mortgage gives an investment company or investor a stake in your home's future equity. However, the investor won't have anything to do with the day-to-day running of your home. They can't make decisions on how you decorate or what remodeling projects you take on. However, they will benefit if your home's value increases. You will also be responsible for any expenses, taxes, or insurance costs.
When your equity sharing agreement contract finishes, you repay your investing partner the amount they initially loaned to you, plus a percentage of the appreciation in your home's value. If your home decreases in value, the investor will receive less money.
A shared equity finance agreement isn't technically a mortgage. It may be easier to qualify for a shared equity agreement than a home loan product. Credit and income requirements are typically more lenient.
What are the pros and cons of home equity investments?
Who could benefit from equity sharing?
Several situations lend themselves to a shared equity finance agreement. You might benefit from a shared appreciation mortgage if one of these scenarios fits your situation.
You want to cash-out home equity but you don't qualify for (or don't want) a HELOC or a home equity loan.
Home equity investments do not have a maximum debt-to-income ratio and they are usually flexible when it comes to minimum credit scores. The underwriting approach is particularly helpful for those who are self-employed, independent workers or others who may be financially stable but lack the consistency of income to qualify for more traditional products like cash-out refinance.
You want to renovate your home without getting into debt.
A shared equity agreement can give you access to cash for home improvements even if you don't qualify for a traditional home improvement loan.
You want to access your home equity for another real estate investment.
Another reason people use shared equity agreements is to pull equity out of their home for an investment in a new rental or vacation property. Many people often do this same thing via home equity loans, but the advantage of shared equity agreemens is you don't have to deal with an additional cashflow burden related with those loans on top of the additional mortgage.
You have a high percentage of your net worth in your home and want to diversify.
These products can also be attractive to those who have a high percentage of their net worth tied to their home and wish to achieve some diversification from an asset allocation standpoint.
You are overwhelmed with high interest debt.
The equity locked in your home can help you pay off high-interest credit when you don't qualify for a low-interest debt consolidation loan.
You need money but you can't afford monthly payments.
If you need cash but can't afford to make additional monthly payments, you should consider a home equity investment. There are no payments or interest rates, and you don't have to repay the investment until you sell the house or the term ends.
You don't have enough money to put 20% on a home.
If you don't have enough for a downpayment, you will pay private mortgage insurance (PMI). That can be costly.
It might save you money, in the long run, to use a shared equity agreement to get enough of a down payment to avoid PMI. However, you could end up paying more at the end of the contract, if your home value rises substantially. If you suspect that will occur, it may be a good idea to buy out your shared equity partner as soon as possible.
You're buying in a hot market.
If you're trying to buy a home in a competitive market, it may help you to have more cash available. You could offer the sellers extra money for the property. Or you could use the money to make a higher down payment than 20%.
How sharing equity works
Determining if you should involve yourself in a shared equity finance agreement is easier if you understand how they work.
When an investor and home buyer or owner set up an agreement, they determine two amounts. The first amount is how much the investor will give the home buyer or owner. The other figure is the percentage of the home appreciation the homeowner must pay the investor at the end of the equity share.
Most contracts stipulate that if the property increases in value at the end of the agreement, the investor receives the initial contribution and the equity share percentage. The latter is calculated according to how much the home appreciated.
Here's an example:
- $50,000 investor contribution
- 30% equity share percentage
- $200,000 increase in property value during terms of the agreement
- You pay the investor the initial $50,000, plus $60,000, totaling $110,000
Note that, in some cases, the payment is based on the overall value of the property instead of a share in its appreciation.
What if your home depreciates?
If your home loses value, you will only pay the investor the initial investment minus their share of the value drop. In the case of a substantial dip in the home's value, the investor could lose their entire investment. If this occurs, you won't pay any money to the investor.
Here's an example:
- $50,000 investor contribution
- 30% equity share percentage
- $100,000 drop in property value during terms of the agreement
- You pay the investor the initial $50,000, minus $30,000 ($100K x 30%), totaling $20,000
Remember, any amount you pay down on your mortgage belongs to you. Investors only have a claim to their original investment and a percentage of an increase or decrease of your home's value.
What are the key features to consider with shared equity agreements?
All investors and their shared equity agreements aren't created equal. Choosing the right investor is crucial if you enter a shared equity agreement. Choose an investor who wants to develop a true partnership with you and share in your collective long-term success.
Before signing, it's a good idea to check you understand the critical features of a shared equity contract.
- Understand the full cost of the contract over time.
- Determine if the investor can share your financial risk if your home depreciates. Additionally, does the investor provide support if you experience financial hardship and fall behind on your mortgage? What will occur if this happens?
- Find out if the potential equity sharing partner is transparent and upfront about process and fees. Check reviews and speak to past clients, if possible.
- Consider the percentage of the investor's share in your home's appreciation. Some investors charge a higher rate than others. Do the math to determine how much the arrangement could cost you and if it fits your budget.
Do shared equity agreements have prepayment penalties?
Most home co-investing companies do not charge a prepayment penalty and you can repay at any time during the term of the agreement. However, you should verify the prepayment policy directly with the company you are considering.
Do shared equity agreements have origination fees?
There is typically a fee associated with the cost of origination and appraisal. Generally speaking, these fees tend to be equivalent to the origination fees associated with a cash out refinance.
What is the difference between a share in home appreciation and home value?
When you agree to a home equity investment, you are effectively selling a stake in your home. There are two ways to do this. You can either sell a percentage of the future appreciation of your home or of its future value. It those two options sound similar, it's because they are. The differences between the two are subtle but it's important you understand them so you can calculate the actual cost of the agreement.
If you sell a share of your home's future appreciation, the investor will receive a percentage of the increase in value of your home when the contract ends or you sell the home. For example, if a home equity investment requires a 30% of your home's appreciation, and your home increases in value by $100,000, you will need to repay the investment and give the investor $30,000. If the home loses value, you can deduct the investor's share in the depreciation from the initial investment repayment.
On the other hand, if you sell a share in the home's future value, the payment is determined by the entire value of the home. So if you sell a 10% share in the value of your home, and the value at the end of the contract is $300,000, the investor would receive $30,000. A 30% share of the home's value, would be $90,000.
How to determine if home co-investing companies are your best choice
The top benefit of a shared equity finance agreement is that you don't have to make any monthly payments. Home co-investing companies don't require you to pay interest. This can be helpful if you're cash-strapped.
However, it is important to understand that shared equity agreements, also known as home co-investing agreements, are contracts, not loan agreements. If your home appreciates in value, you may have to pay back much more than you would have had to with a regular financing method, such as a mortgage or a personal loan.
Here are a few examples of shared equity agreements in action you can use to determine whether shared equity agreements are a good choice for you.
Scenario #1: Cashing out some home equity
Julie has a home worth $500,000. She still owes $300,000 on her mortgage and has $200,000 in home equity. She wants to cash out $50,000 and reaches out to an equity sharing company to make it happen.
Equity sharing agreement
Julie agrees to sell $50,000 of her equity in exchange for a 25% stake in her home's appreciation over the next 10 years.
Repayment
When the 10-year term is up, it's time for Julie to pay. Here are three possible outcomes:
| Scenario #2 | Initial home value | Home value at time of repayment | Investment amount | Investor Stake | Total gain/loss | ROI for investor | Total repayment due |
|---|---|---|---|---|---|---|---|
| Appreciation Scenario | $500,000 | $550,000 | $50,000 | 25% | $50,000 | $12,500 | $62,500 |
| No change | $500,000 | $500,000 | $50,000 | 25% | $0 | $0 | $50,000 |
| Depreciation Scenario | $500,000 | $450,000 | $50,000 | 25% | -$50,000 | -$12,500 | $37,500 |
Scenario 2: Securing a down payment
Johnny wants to buy a home that costs $250,000. To avoid PMI, he needs to put down $50,000. He saved up $25,000, but isn't sure how to get the rest. He hears about a shared equity investment company and finds out they will lend him the other $25,000. In exchange, they get a stake in your property and its future appreciation or depreciation.
Equity sharing agreement
Johnny's chosen shared equity company sets the agreement length at 30 years. That means he won't have to make a single repayment on the amount until he sells the home or thirty years have passed, whichever comes first. At the end of the agreement, Johnny will repay the initial investment along with 35% of the property's gain or loss over the span of the agreement.
Repayment
15 years later, Johnny is ready to sell his home. Depending on how the value of his home has changed, here's what could happen.
- If Johnny's home has increased in value to $350,000, he'll owe the investor the initial investment of $25,000 plus 35% of the $100,000 gain ($35,000). The total payment would be $60,000.
- If the value of Johnny's home stayed the same, he would owe the investor the initial investment of $25,000 and nothing more.
- What if Johnny's home value drops to $200,000? He'll need to repay the difference between the initial investment ($25,000) and the investor's percentage of the loss (35% of -$50,000=-$17,500). The total repayment amount would be $7,500.
| Scenario #2 | Initial home value | Home value at time of repayment | Investment amount | Investor Stake | Total gain/loss | ROI for investor | Total repayment due |
|---|---|---|---|---|---|---|---|
| Appreciation Scenario | $250,000 | $350,000 | $25,000 | 35% | $100,000 | $35,000 | $60,000 |
| No change | $250,000 | $200,000 | $25,000 | 35% | $0 | $0 | $25,000 |
| Depreciation Scenario | $250,000 | $200,000 | $25,000 | 35% | -$50,000 | -$17,500 | $7,500 |
In the appreciation scenario, Julie's home increases in value to $550,000. She'll have to repay the initial $50,000 plus 25% of the $50,000 appreciation, for a total of $62,500. She is not ready to sell her house, so she'll have to pay out-of-pocket or refinance the debt.
However, refinancing the debt will result in additional financing fees. And even if she sells her home, the $37,500 she gains from the appreciation won't cover the full $50,000 repayment. This outcome could be problematic for some homeowners.
Before making a shared equity agreement, check market trends and predictions to make sure you've got a good chance of gaining money instead of losing it. Use a table like those in the examples above to figure what you would end up paying in a variety of circumstances.
Getting started with a shared appreciation mortgage
If you want to cash out equity and have liquidity problems, equity sharing agreements may be your answer. The companies in the list above provide the best shared-equity agreements currently available. SuperMoney's shared equity agreements comparison tools can help you dig deeper in the terms involved in shared-equity contracts.
