What Is A Home Equity Agreement?

Real estate owners often ask: What is a home equity agreement?

In simple terms, it’s a contract that provides homeowners with money from a third-party investor in exchange for future appreciation and a share of their home equity. In other words, the contract specifies that an investor will pay you a lump sum of cash as an incentive for selling a portion of the equity that you hold in your home. That said, keep in mind that you’ll eventually have to repay the funds within a predetermined time period that’s been mutually agreed upon, or at such time when your home is sold.

Put simply, the home equity agreement effectively allows you to use equity that you hold in your house and a potential future increase in the value of your property as a form of leverage through which to secure additional funds. Sums secured this way can be utilized for making purchases, paying down debt, financing upgrades and remodels, or a host of other purposes. Benefits for homeowners include immediate access to one’s equity in the home and no monthly payments. But again, fees apply to such contractual arrangements, and repayment terms come with time restrictions attached.

In any event, despite the caveats attached to such a contract, it could be a good option for you. Let’s take a closer look at pros, cons and the definition of a home equity agreement in practice to get a sense of how you might benefit from one.

What Does A Home Equity Agreement Mean?

A home equity agreement or HEA (occasionally referred to as a home equity sharing agreement or home equity investment) is a contractual arrangement made between a property owner and an investor or investment firm. Under its terms, the homeowner is able to access a certain portion of the property’s value at the time of the contract’s execution. As opposed to alternate financing vehicles such as home equity lines of credit (HELOCs) or home equity loans, sums that you gain access to through the deal are not subject to monthly interest payments.

At the same time, by signing such a contract, you’ll grant an investor a lien on your home in exchange for a lump sum of money that the financier offers in exchange for a certain fraction of your property’s appreciated value. Any monies provided under such a setup need to be repaid upon the sale of the house, or within a certain predetermined and mutually agreed time period, typically 10 – 30 years. As part of the contract, you’ll also be required to properly maintain and upkeep the property, and pay property taxes, homeowners insurance and closing costs or fees associated with the home sale.

As you might imagine, home equity agreements are only becoming more popular as the prices of real estate properties and goods continue to rise, as does the need for access to liquid capital. The deal structure provides potential benefits for both parties and can help put cash in your hands faster.

How A Home Equity Agreement Works

Most home equity agreements are structured so as to provide for an investor paying you a lump sum of cash today in exchange for a certain portion of your future home equity. Under most typical deal structures, the arrangement takes the form of a lien on your property, which guarantees the investor a certain amount of proceeds to be deducted from your home’s future sale. This portion of earnings is specified in the form of a percentage of the total amount to be received from the property’s ending price. Should the price of your home decrease, the total amount to be repaid should also decrease commensurately as well.

In the event that your home does not sell, however, most home equity agreements provide for a typical time frame of 10 – 30 years for repayment. At this time, you’ll be obligated to repay the principal itself as well as the portion of the home’s appreciation that you agreed to furnish the investor. As opposed to home equity loans and HELOCs, which come with interest payments attached as a way to compensate financial providers, it’s this agreed percentage of future equity in your home which you’ll pay out to investors as the return on investment for taking a risk on the contract here.

Note that homeowners whose properties have a lien placed on them can find that their ability to sell or refinance the real estate is impacted. A property owner who enters into a home equity agreement also still remains liable for closing costs at the time of sale, like title insurance, recording fees, appraisal charges, etc.

What Are The Requirements Of Home Equity Agreements?           

Investors will require you to meet certain minimum eligibility requirements in order to quality for a home equity agreement. We take a closer look at typical factors that financial institutions consider below.

• Home value: Certain investors and investment companies will only invest in properties that are of a certain minimum value. By way of example, select providers will require that your home value be at least $250,000 or above.
• Credit score: Financial companies have different minimum credit score requirements, some of which may extend financing to those with lower scores or less well-established credit, for example, those with scores around 500. But generally speaking, having a credit score of 650 or above will help you enjoy access to more opportunities.
• Loan-to-value (LTV) ratio: Again, requirements differ by financial provider. As a general rule though, companies will wish to see homeowners hold an LTV ratio of 80% or better, meaning that at least 20% of the total mortgage on the home has been paid off.
• Current mortgage balance: Firms will also look at how much you currently owe in outstanding balances on your home, which impact the total amount of equity that you hold in a property. Lenders vary in eligibility requirements, but will universally require that you hold a certain minimum percentage of equity in the property after the home equity agreement is accounted for.
• Debt-to-income (DTI) ratio: There’s no universal rule on how low your DTI needs to be that applies to all financial home equity agreement providers. But such financial instruments are often a preferred choice for individuals whose high DTI ratios or lower credit scores make it more challenging to qualify for a traditional loans or lines of credit as a financing option.

Advantages And Disadvantages To Home Equity Agreements

Be advised that home equity agreements come with both potential upsides and downsides attached as well. Before entering into one, you’ll want to weigh the pros and cons for yourself to determine if a home equity agreement is a good idea for you.

Pros

• No interest charges or monthly payments attached. As opposed to alternate funding methods like refinancing your mortgage of taking out a personal loan, you won’t be subject to interest charges or be required to make monthly payments on a home equity agreement. That’s helpful if spare funds are hard to come by, or your monthly budget and cash flow can benefit significantly from not taking on additional debt.
• Credit score requirements aren’t as stringent. Typical home equity agreements generally come with less demanding credit score requirements attached. That’s helpful for individuals who may have lower credit scores that inhibit their ability to access alternate financing solutions, but own and hold significant value in their homes.
• Funds can be used for myriad purposes. You won’t find requirements or restrictions placed on how you can use monies received under the terms of a home equity agreement. Rather, you can utilize these extra dollars toward whatever purpose you like, like paying for large expenses, buying down debt or making major home improvements.

Cons

• Lump sum payments may create financial hiccups. Monies paid to homeowners may be taxable in certain states, cities and counties, depending on where you reside. Receiving a large sum of money at one time may also tempt some individuals to overspend or utilize funds less judiciously than if the cash was parceled out over an extended time period.
• You may wind up paying more in the end. You’ll also want to crunch the numbers and determine if the math adds up. For instance, if the appraised value on your property is too low, investors may gain a larger portion of equity at your potential long-term expense. Also closing costs (which you’re obligated to pay) may put a pinch on your pocketbook to the tune of thousands in added expenses.
• Total expenses can exceed alternate financing options. You may be asked to give up a larger amount in value by parting with equity than it would cost you overall to simply make interest payments on another financial instrument. Should the value of your home remain the same, you may also wind up paying back additional expenses on top of the equity you initially took funds out against. And if your home’s value depreciates, you’ll still be obligated to pay money to the investor.
• A balloon payment is required. At the end of the agreement term, you’ll be obligated to make a balloon payment to the investor – whether or not you’ve actually sold the house. Likewise, if you choose to take a buyout and end the agreement before selling the property, you’ll still have to make a large one-time payment as well.

How To Choose A Home Equity Agreement Company

All manner of financial institutions offer property owners access to home equity agreements. At the same time, because terms and conditions and the specific details of individual offers will differ by provider, you’ll also want to shop around and compare several options before settling on a final investor.

When researching and reviewing possible providers, be sure to look at factors such as:

• Amount of equity requested in the property
• Proposed sums to be provided to you
• Length of term for the home equity agreement
• Eligibility requirements for applications
• Which fees, costs and expenses you’ll be liable for
• Whether funds be taxable to any extent
• If a prepayment penalty is applicable

The right home equity agreement should be based on your individual financial situation and ability to repay any sums provided. That means having to consider factors such as future earnings and income, the relative health of real estate markets and the economy, and your capacity to make good on specified contractual obligations.

What Are Alternatives To Home Equity Sharing Agreements?

Keep in mind that a variety of financial products can provide additional sources of funding should you find yourself in need of extra cash.

• Home equity loan: When comparing home equity agreements and home equity loans, it’s important to understand how the latter works in practice. Under the terms of a home equity loan, you’re effectively electing to utilize the equity that you’ve built up in your property to date as collateral in exchange for receiving a lump sum of money from a lender. As with a home equity sharing agreement, you can put any funds received from doing so toward all manner of tasks, such as making property upgrades and home improvements. But at the same time, outstanding balances that you have borrowed are repaid monthly and charged on top of current monthly mortgage bills. That’s why you’ll often hear home equity loans referred to as second mortgages, and you’ll be responsible for making payments on both your primary home mortgage loan and home equity loan each month. If you choose to sell your home before your home equity loan is paid off in full, you’ll also be required to pay the remaining balance at closing. But the overall cost of it may be lower than that associated with giving up equity in your home, as you would in a home equity sharing agreement.
• HELOCs: A home equity line of credit (commonly referred to as a HELOC) provides you with a revolving line of credit that you can use to consolidate debts or make large purchases – noting that access to the HELOC is secured by your residence. Functioning similarly to a credit card, a HELOC allows you to borrow up to a preset funding limit for a predetermined number of years (typically 10) known as a draw period. Throughout the period, you’ll generally make only interest payments on the balance, which you can also repay in part if you need more funds to draw on. At the end of the draw period, a repayment period (generally about 20 years) starts, and both principal and interest payments come due. As opposed to a home equity agreement, a HELOC requires you to make more frequent and regular payments – but it may also prompt you to spend more strategically, and comes with less overall expense than giving up equity in your home.
• Cash-out refinance: Should you instead opt for a cash-out refinance, you’ll basically replace your current primary home mortgage with a brand-new mortgage, leaving you with one updated monthly payment. The way agreements operate, you’d basically be taking out a new loan for more than you currently owe your present lender and receive any extra amounts back in cash after closing. You could then choose to use some of the equity that you’ve built up in your property and add it on to a new mortgage.
• Reverse mortgage: A reverse mortgage, which you may also hear occasionally referred to as a home equity conversion mortgage (HECM), is for homeowners aged 62 or older. It allows you to use your home equity to pay off the remainder of your primary loan, and then use the rest of the money for whatever purposes that you’d like, such as paying down living expenses, amassing savings, paying off debt, etc. Options are designed to help folks of retirement age access their funds and eliminate monthly payments.

The Bottom Line

A home equity agreement allows property owners to receive cash from an investor in exchange for future appreciation and a share of the equity that homeowners hold in their residence. You get a lump sum that you can spend for any purpose here and now – your investor receives a potentially large windfall for their initial investment down the road.

While you won’t make recurring monthly or interest payments on a home equity agreement, you will have to repay any funds that an investor provides within a mutually agreed time period, or when your home is sold. Such arrangements are often beneficial for individuals with lower credit scores or who may find it harder to obtain other financing instruments. But the contracts may prove more expensive than alternate financing products in the end, and come with a large balloon payment attached down the road – whether you’ve sold your home or not.

Noting this, it’s important to consider your personal financial situation, ability to meet commitments and the upsides and downsides of home equity agreements, as well as to compare offers from multiple investors. On the bright side, the contracts prove a helpful form of financing for thousands of homeowners annually.

Note that a good credit score is a reflection of good financial habits, and that mortgage lenders and financial institutions will look to it when weighing your access to potential funds. Looking to see what options are available to you, or start the home buying process? Be sure to reach out and start your mortgage approval application today!