How to Tap Into Your Home Equity Without Getting Into Debt

There are several ways to cash in your home equity. However, many homeowners are finding it difficult to qualify for traditional home equity credit products. Home equity investments offer a new approach to home equity financing. It’s not for everyone, but it provides advantages to some homeowners. 

Average home equity per household with a mortgage

Phones are ringing off the hooks for home equity lenders as an increasing number of Americans seek to unlock some of the equity tied up in their homes. It’s no surprise considering more than 36 million people have filed for unemployment benefits since the coronavirus pandemic started, and interest rates are at record lows.

Home equity levels are hitting historic highs

Homeowners have good reason to see their home equity as a piggy bank in times of crisis. The average family with a mortgage had a total of $177,000 in home-equity wealth. In total, American homeowners have amassed $18.7 trillion in home equity, according to the Federal Reserve. Even if you only consider homeowners with a mortgage, there are 44.7 million households who have positive equity — a total of $6.2 trillion in tappable income locked in their homes.

What is tappable equity? Tappable equity is the share of equity available to homeowners with mortgages to borrow against before they hit the maximum loan-to-value threshold of 80% that most equity lenders require as a cushion to approve a loan. For example, if your home is worth $100K, and you have a balance of $50K on your mortgage, your tappable equity is $30K ($100K x 80% – $50K).

Homeowners are struggling to access their home equity

Despite having all that wealth locked in their homes, many Americans are getting their home equity credit applications denied. Some homeowners are finding the hard way just how illiquid an asset home equity can be. There are two main problems.

First, lenders are concerned about the spike in unemployment, and they are backlogged by the surge in applications for mortgage refinancing and home equity credit.

Second, American households are already dealing with high levels of debt. Many are overextended, and their debt-to-income ratio won’t qualify them for a new loan despite having equity. The latest data by the Federal Reserve shows the steepest increase in household debt since the Great Recession. Overall household debt hit $14.5 trillion. That is $1.5 trillion more than the previous peak in 2008, and 27% more than our last “debt trough” in 2013.

How can homeowners access their equity without getting further into debt?

Home equity investments, also known as shared equity agreements, are a relatively new product that allows homeowners to cash out on their equity without getting into debt. It works like this. 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 the value, the investor also shares in the loss.

Who can benefit from a home equity investment?

Home equity investments are not for everyone. If you live in an area where home values are increasing substantially, it can be an expensive way to cash in on your home equity. Also, the amounts you can get with a home equity investment are typically much lower than with a HELOC or a home equity loan. Availability is another thing to consider. Shared equity agreements are still a novelty and only available in select states. However, if you need cash now and you don’t want to get into debt, it can be a smart option. There are no monthly payments or interest to worry about.

Here are some scenarios where an equity investment may be beneficial:

  • You want to fund your education, but you don’t qualify for student loans with low interest rates.
  • You’re overwhelmed by high-interest credit card debt, and you can’t afford the monthly payments.
  • There is plenty of equity in your home, but you don’t qualify for a HELOC or a home equity loan, but you need money to cover an unexpected expense.
  • You don’t have the savings (or sufficient credit) to pay for the down payment on the house you want.

What are the pros and cons of shared equity investments?

Shared equity agreements can be a lifesaver for asset-rich but cash-strapped homeowners. But there are also some serious downsides to consider.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks to consider.

Pros
  • No monthly payments, no interest, and no debt.
  • Flexible eligibility requirements.
  • It can help you finance a down payment or any other major purchase.
  • It allows you to pay off high-interest loans without carrying additional debt.
  • No minimum debt-to-income ratio.
Cons
  • You have to either pay back the investment or sell the house if you stay longer than the contract term.
  • Typically, you need a loan-to-value ratio that is below 75%.
  • Homeowners with fair or even poor credit are considered.
  • Fees and closing costs typically range from 3% to 5% of the investment amount.
  • HELOCs and home equity loans offer larger amounts.

How to compare the best home equity financing option?

The best home equity option for you will depend — among other things — on how much money you need, your debt-to-income levels, how much equity you have, and your credit history. HELOCs provide more flexibility — you only have to withdraw what you need —  and the lowest fees and interest rates.

A home equity investment could be a good option if you can’t qualify for a HELOC or a home equity loan, and you don’t want to get into debt. The table below summarizes the key terms and features of the most popular home equity financing options. These are rough estimates. The actual terms will vary depending on the lender and investor.

Shared Equity InvestmentsHome Equity LoanHELOCCash-Out Refinance
Term10 – 30 years~10 years~10 years10 – 20 years
Average debt-to-incomeUsually not a factor~43%~43%50%
Average credit scoreTypically ~600-650 (no fixed minimum)680+680+620+
Max. loan-to-value75%80-85%80-85%Max LTV of 70%
Closing costs3-5%3-5%~$100 a year in fees4-5%
Additional feesNo prepayment penaltiesTypically charge prepayment penaltiesMinimum annual draw. Prepayment penalties and late fees.Prepayment penalties and cancellation fees