Home Equity Agreement or HELOC: How to Choose the Right Option

What sets a home equity agreement apart from a HELOC?

A home equity agreement lets you trade a share of your home’s future equity for a lump-sum payout from an investor. A HELOC, or home equity line of credit, works more like a credit card by allowing you to borrow against your home equity over time.

Home equity agreements do not require monthly payments or interest. HELOCs usually do, although your payments depend on how much of the line you use.

Home equity agreements are often easier to qualify for than HELOCs. Some home equity investment firms accept credit scores as low as 500, while many HELOC lenders want scores between 620 and 680 or higher.

How a home equity agreement works

Under a home equity agreement, you receive an upfront lump sum in exchange for giving up a portion of your home’s future value. You do not make monthly payments, but you must settle the agreement by a set deadline, generally within 10 to 30 years depending on the investor.

When the agreement is settled, you owe the investor an agreed-upon percentage of the home’s value at that time. If your home has risen sharply in value, the amount you repay could be much higher than what you originally received.

These agreements often come with an initial service fee and upfront charges for appraisals, notarization and other expenses. Those costs are usually taken out of the money you receive at closing.

How a HELOC works

A HELOC turns part of your home equity into a revolving credit line. You can draw from it as needed during the draw period, which commonly lasts 10 years.

During that period, you typically pay interest only on the amount you have borrowed. Once the draw period ends, you begin making principal-and-interest payments for the remainder of the loan term, which is often another 20 years.

Another advantage is flexibility: you can borrow, repay and borrow again up to your approved limit. That limit is usually 80% to 90% of your home’s current value, minus any mortgage balance still owed.

What would each option cost on a $400,000 home?

There is no exact apples-to-apples comparison because the pricing depends on several factors. For a home equity agreement, the cost varies by investor and by how much equity you sell. The examples below are only for illustration.

Home equity agreement

Assume you sell a 10% stake in a $400,000 home to Hometap, an equity investment company that caps its return at the equivalent of an 18.5% annual interest rate. In this example, you would owe 18% of your home’s value if you settled at the end of a 10-year agreement. The amount would differ depending on whether your home value fell by 4% or 8% each year, stayed flat, or increased by 3.25% or 8% annually by the end of the term.

HELOC

HELOC costs also vary widely, depending on how much you borrow and the interest rate. Most HELOCs carry variable rates that can rise or fall over time, which means monthly payments and total borrowing costs can also change. Some lenders do offer fixed-rate versions.

For a simple example, consider a $40,000 fixed-rate HELOC at 8.25% with a 10-year draw period and a 20-year repayment period. If the full amount were borrowed at the start, the total cost over 30 years would be about $114,800, including roughly $74,800 in interest.

Variable-rate HELOCs are more complicated. Lenders generally begin with the prime rate and add a margin to set the starting rate. If the prime rate goes up, the HELOC rate usually follows. That makes long-term cost estimates harder to pin down.

How they stack up against a home equity loan and a reverse mortgage

Home equity loans and reverse mortgages are two other ways to turn home equity into cash. A home equity loan provides a lump sum based on part of your equity, which you can use for any purpose. You repay it in monthly installments, plus interest, over a term of five to 30 years.

Reverse mortgages are available only to homeowners age 62 and older for government-backed loans, or age 55 and older for some private products. As the name implies, the payment flow is reversed: instead of paying the lender, you receive money from your home equity. You can take the funds as monthly payments, a lump sum or a line of credit. Repayment is due when you move out permanently, sell the home or die.