August 20th, 2024
Home equity investments (“HEI”), also known as shared appreciation agreements, offer homeowners a unique opportunity to access the equity in their property without taking on additional debt. An HEI agreement provides you with a lump sum cash payment today in exchange for granting the HEI provider a share of the future change in value of your home. You get cash up front in exchange for giving up a share of your home’s future change in value. Unlike many other home equity products, an HEI has no monthly payments or periodic interest charges. If you’re considering tapping into your home equity but aren’t sure if you’re a good candidate for an HEI, there are several factors to consider. Following are a few examples.
How much equity you have: The amount of equity you have in your property may help you determine if and how you choose to access your home equity. Like traditional home equity access products–for example, a HELOC–an HEI typically has a CLTV requirement. CLTV stands for Combined Loan-To-Value, and when getting an HEI or a loan, is usually represented as a percentage. For example, many HEI providers require a maximum CLTV of 75%. This simply means your combined HEI funding amount, i.e., the amount of cash you receive up front, plus your current mortgage balance(s), can’t exceed 75% of the home’s value.
Financial Stability: Assessing your financial stability is crucial before pursuing a home equity investment. Consider factors such as your income, expenses, savings, and credit score. Since HEI don’t require monthly interest payments, they can be a viable option for those with variable income or seasonal / “lumpy” cash flow. However, with an HEI it’s still essential to ensure that you’ll be able to cover ongoing expenses and any unexpected costs that may arise in life.
Financial Goals: Evaluate your financial goals and how tapping into your home equity aligns with them. Are you looking to fund home improvements, consolidate debt, invest in education, or cover major expenses? HEI can provide the necessary liquidity to achieve these goals without adding another monthly payment to your budget. If you have specific financial objectives that require immediate funds, an HEI may be a suitable option. Be sure to ask your financial advisor what they think.
Risk Tolerance: Assess your risk tolerance and comfort level with choosing to give up a share of your home’s appreciation. Although many HEI have protections in place that limit how much of your home’s change in value the HEI company can receive at the end of the agreement, you still need to be comfortable giving up a chunk of your home’s change in value. This is fundamentally different than a traditional loan product (e.g., a home equity loan or HELOC), where you borrow against your equity and make monthly payments of principal and interest until loan maturity.
Understanding the HEI agreement term and what happens when the agreement ends: Many HEI products have a 30-year term, and allow you to “buy out” the agreement at any time during that period. Other HEI providers offer a 10-year term, and/or place restrictions on your ability to buy them out. Among other variables, be sure to consider the term length when considering an HEI provider, as it may affect your long-term financial flexibility. HEI agreements with a 10-year term might not be right for you if you don’t plan to sell or refinance your home within 10 years, as you could find yourself forced to sell or refinance in order to pay off your HEI provider at the 10-year mark. On the other hand, HEI agreements with a 30-year term provide greater flexibility in terms of when and how you choose to exit your agreement.
A typical HEI agreement terminates when you sell your home, and your HEI provider’s share of the property’s change in value is settled out of the gross sale proceeds at closing. Alternatively, some homeowners choose to terminate their HEI agreement through a home refinance, by using some of refinance proceeds to buy out their HEI agreement.
Whether through a sale, refinance, or otherwise, when you exit your HEI agreement you generally pay back the amount you received at the beginning of the agreement, plus or minus the HEI provider’s agreed-upon share of your home’s change in value.
Use Cases: HEI provide a lump sum of cash that can be used according to the specific homeowner’s needs. Some homeowners may use their HEI to repay high-interest debt and improve their credit, while others may use the cash to renovate their home, pay for education, or to help fund retirement, among others. While there are few, if any, limitations on what your HEI funds can be used for, homeowners should consider how they intend to use the funds when determining whether or not an HEI is the right fit.
In conclusion, determining if you’re a good candidate for a home equity investment requires careful consideration of your equity position, financial stability, goals, and long-term plans, as well as your risk tolerance. You should always consult with your financial and other trusted advisors when considering any financial product, including HEI. If you have stable finances, clear financial objectives, and an understanding of potential risks and pitfalls, an HEI could be a valuable tool for achieving your goals and securing your financial future.
