Homeowners build up equity with each mortgage payment. As homeowners keep up with these monthly mortgage payments, their properties can appreciate and unlock additional equity. You may have to access home equity for various reasons, such as covering home repairs, an upcoming vacation, or emergencies.
However, you may not like the idea of making monthly loan payments or worrying about what happens after a HELOC’s draw period concludes. Luckily, there is another way to tap into your home equity. Shared equity agreements allow you to receive capital from your home equity without taking on any debt. You don’t even need a good credit score to get funds through this method. However, it comes with pros and cons. This guide will explore how home equity investments work and who may want to consider them.
What are Home Equity Investments and Shared Equity Agreements?
Home equity investments and shared equity agreements result in instant capital. Instead of taking out a loan or a line of credit, you agree to give a company a percentage of your home equity. This share allows the company to benefit from the appreciation of your property over time.
How Do Home Equity Investments and Shared Equity Agreements Work?
Home equity investments and shared equity agreements allow the investing company to gain value from their investment if your home gains value. The investing company does not receive a return on its investment until you decide to sell your home. The investing company hopes that your home will appreciate over time.
Homeowners agree to these types of deals because they don’t have to worry about monthly loan payments or what happens once the drawing period ends. However, these agreements can get expensive if your home appreciates rapidly.
Are Home Equity Investments and Shared Equity Agreements the Same?
Home equity investments and shared equity agreements are the same thing. This strategy involves giving an investor a portion of your home equity in exchange for a lump sum. You have flexibility in how much home equity you give to the investing company. Giving more equity will increase your lump sum, but you will have to pay it back when you sell your home. Some investors give the homeowner the option to buy them out to reclaim all of their home equity.
Where to Get Home Equity Investments and Shared Equity Agreements
Homeowners can search for investing companies that offer home equity investments and shared equity agreements. It is a good idea to compare several options to see what type of capital you can obtain and how much home equity you have to give up. Homeowners should also see if they can repurchase their home equity share from the investing company.
Example of a Home Equity Investment and Shared Equity Agreement
Assume a homeowner has a $1 million property and a $400,000 mortgage payment. The mortgage payments and other expenses make a home equity loan or a line of credit unfeasible for the homeowner. Instead of following that approach, the homeowner receives $300,000 from a shared equity agreement. Most of these investing companies have maximum loan-to-value ratio requirements between 70% to 85%. In this case, the LTV ratio is 70%.
The homeowner does not have to pay interest or cover monthly loan payments to receive the $300,000. Assume that this same homeowner sells the property for $2 million. Before receiving the proceeds, the homeowner must pay the investing company for its home equity share. The $300,000 investment from the company was 30% of the home’s value at that point in time. Since the property has doubled, the home equity share has also doubled to $600,000.
The homeowner walks away with $1.4 million, but borrowing $300,000 with this strategy turned into a $600,000 expense. That’s not a good return, but home equity agreements can make sense for many reasons. The pros and cons will shed light on several factors to consider.
Pros of Home Equity Investments and Shared Equity Agreements
These are some of the advantages of capitalizing on a home equity investment or shared equity agreement.
Quick Access to Cash
A home equity investment doesn’t take as much time to access as a home equity line of credit or home equity loan. Most of these agreements get approved within 30 days, while it can take up to two months to receive a home equity loan or a line of credit.
Easier to Qualify
You don’t need a good credit score to qualify for a home equity investment or shared equity agreement. As long as you have enough equity in your home and can fulfill the loan-to-value ratio requirement, you can qualify for this financial product.
No Income and Credit Score Requirements
These investing companies do not have any income or credit score requirements. These requirements hold many people back from accessing the capital they need. However, shared equity agreements make capital more attainable for homeowners.
Lump Sum Cash Payment
You will receive cash right away that you can use for anything. The investing company doesn’t care how you will use the funds, and you can utilize them instantly.
Funds Can be Used for Anything
You can use the funds to cover any expense. Homeowners can use the funds for repairs, vacations, living expenses, or anything else.
No Monthly Payments and Interest
Your budget stays the same. You do not have to worry about monthly mortgage payments or interest accruing on your home equity line of credit.
Investor Shares in Depreciation
Rising interest rates and declining purchasing power can result in home price depreciations. If your home loses value after you get into one of these arrangements, the investor shares in the losses. If you want to buy back your share, it will become more affordable for you to do so.
Cons of Home Equity Investments and Shared Equity Agreements
Home equity investments and shared equity agreements have their advantages. However, it is important to consider these factors before getting into one of these arrangements.
Loan Must be Paid All at Once
You have to pay the entire loan when you sell your property. Homeowners don’t get the flexibility of spreading the principal across many payments.
You May Pay More Than What You Get
In the example from earlier, a homeowner received $300,000 but then had to pay $600,000 after tier home doubled in value. This scenario is possible if your home appreciates. You may end up paying far more than you received from the investing company. While the same rule applies with interest, you may have to pay more with this approach than with interest on a loan.
Substantial Home Equity Requirement
Some investing companies require a high percentage of your home equity before giving you capital. This high requirement can limit how much you make when selling your home. Some homeowners rely on the proceeds from a home sale to downsize and live comfortably in retirement.
Various Fees and Costs
You will have to contend with several fees and costs to enter one of these arrangements. Home equity loans and lines of credit also have various fees and costs, but it is a good idea to compare them before committing to any option.
Risk of Losing Your Home
Some of these contracts end in 10 years. That means you will have to repay the investing company enough money for its entire equity position. If you cannot make that payment, you may end up losing your property. Some companies have a 30-year term, which gives you more time to accumulate funds. However, a home can appreciate considerably within 30 years. You may have to sell your home to cover the debt.
May Not be Available in Every State
Not every state allows home equity investments or shared equity agreements. Homeowners have to check the rules in their states to see if they can enter one of these arrangements.
How Do You Calculate Your Home’s Equity and How Much Can You Get?
Investors can calculate their home equity by deducting their mortgage balance from their home’s value. For instance, if your home is worth $500,000, and you have $100,000 remaining on your mortgage, you have $400,000 in home equity.
Investing companies tend to set 70% to 85% LTV ratio limits. If it’s 70%, your mortgage balance and home equity agreement cannot exceed $350,000. Since the homeowner in this example has a $100,000 mortgage balance, that individual can receive up to $250,000. A higher LTV ratio maximum results in more potential capital.
How Repayment of the Equity Investment Works
You have to repay the equity investment through a one-time payment at the expiration of the term. Terms typically last 10-30 years, but it is up to the investing company. Some homeowners have to sell their homes to repay the investing company’s share. However, you can repay it over time before your home gains value. If your home loses value, it will become more affordable to pay off the equity share.
How to Best Use the Money from Your Home’s Equity
It takes considerable effort to tap into your home equity. These are some of the best ways to use those funds.
Home Improvements
You can get the extra cash to make improvements to your home. These improvements can increase the functionality of your home and lead to a higher valuation. However, a higher valuation will also increase the value of the equity share.
Debt Consolidation
You can use the proceeds from a shared equity agreement to pay off your other debts. This version of debt consolidation eliminates monthly payments. You can start fresh and decide to repay the shared equity agreement over time or wait until you sell your home.
Emergency Expenses
Getting extra capital when you need it the most can reduce stress and help you cover the expenses that matter the most. Saving money in an emergency fund can help, but medical expenses and similar emergency costs can grow quickly.
Education
College tuition continues to get more expensive. A shared equity agreement can help make those costs more manageable.
Investments
You can take the money from a shared equity agreement and invest in stocks and other assets. However, this strategy is risky and only makes sense if the return from your investments exceeds your home’s appreciation. No investment is a guarantee, and you should consider that risk before using your shared equity agreement proceeds for this purpose.
Starting A Business
A home equity investment can help you raise enough funds to launch your startup. You won’t have to ask friends and family to raise funds, and you won’t have to worry about monthly business loan payments when you are getting started.
How Can You Build Home Equity?
The more equity you build, the more of it you can borrow when the time arrives. Even if you don’t intend to borrow money, building equity helps you get closer to a fully paid-off mortgage. You can use these strategies to build home equity,
Mortgage Payments
Every monthly mortgage payment gets you closer to a debt-free home and helps you build equity. You have to make these payments to keep your house, but they also increase your net worth and borrowing options.
Paying More Than the Minimum
The monthly mortgage payment represents your minimum payment. However, you can pay more than the minimum each month to trim your mortgage balance and minimize your interest payments. Some people make two mortgage payments per month even though lenders will only ask for one monthly mortgage payment.
Home Improvements and Renovations
Home improvements and renovations increase your home’s value. These additions increase your home equity, which you borrow through various home equity financial products.
Increase in Property Value
You can control your property’s appreciation through home improvements and renovations. These efforts, when done correctly, can result in meaningful appreciation. However, some homes gain value through natural appreciation. Since homes are available in a limited supply, they tend to rise with inflation. If an area experiences high population growth, the homes in that area can gain more value and outpace the real estate market.
Large Down Payment
Every dollar you put into your down payment increases your home equity. The funds you use for a down payment don’t get whittled by interest. You can make a down payment as low as 3% for some loans, but a 20% down payment will help you avoid private mortgage insurance. Making a higher down payment, such as a 30% down payment, will give you a head start with your home equity.
Other Ways You Can Access Your Home’s Equity
Home equity investments and shared equity agreements give homeowners the opportunity to tap into home equity. However, homeowners may want to consider these alternatives. Even if you opt for a shared equity agreement, it is a good idea to review all of the available choices to decide which one is right for you.
Home Equity Loans
Home equity loans allow homeowners to receive a lump sum that they must then repay over monthly installments. You can get a home equity loan with a 30-year term to minimize your monthly payments. Home equity loans provide predictability due to their fixed interest rates. Market conditions will not change your monthly payments. These loans tend to become more manageable as the years go by since inflation tends to increase people’s nominal paychecks. You don’t have to worry about what happens if your home’s value appreciates while you pay off the loan.
However, you will have an extra monthly expense. Falling behind on these payments and defaulting on the loan can cause you to lose your house. Home equity loans tend to have lower interest rates than other types of loans since they use your home as collateral.
Home Equity Lines of Credit (HELOC)
Home equity lines of credit allow you to take out a credit line against your home. These credit lines usually have variable interest rates, but you only pay interest when you borrow against the credit limit. Home equity lines of credit have drawing periods where you can borrow capital up to the credit limit. The minimum monthly payments tend to be generous, but interest will accumulate on your credit line if you don’t pay it back in full. After the drawing period concludes, the remaining balance on the HELOC will be converted into a loan.
Cash-out Refinancing
Cash-out refinancing allows you to convert your current loan into a new loan with a higher balance. Instead of taking out a separate home equity loan or a line of credit that comes with separate payments, a cash-out refinance lets you streamline your monthly payments. You can even add more years to the back of your loan to minimize the monthly payments.
However, a cash-out refinance will essentially overwrite your existing loan. If you secured a low interest rate and reasonable terms, a cash-out refinance might not be the best choice. However, if you have improved your credit score since getting your original mortgage, and you can qualify for a lower interest rate and better terms, a cash-out refinance may be the best choice.
