Understanding a Home Equity Agreement

Home equity agreements allow homeowners to tap into the increased value of their property to support a range of financial goals. They may be used to fund renovations, pay down debt or cover a major purchase.

So what exactly is a home equity agreement, and what should you know before signing one? The overview below explains the basics, how these arrangements work, and the main advantages and drawbacks, along with a look at some of the leading home equity sharing companies.

What is a home equity agreement?
Popular home equity sharing companies
How to find the best home equity agreement companies
Alternatives to home equity agreements
Latest news in home equity
Summary of Money’s What is a home equity agreement

What is a home equity agreement?

A home equity agreement, or HEA, is also known as home equity sharing, a home equity sharing agreement or a home equity investment. It is a deal between a homeowner and an investor or investment firm that lets the owner unlock part of the equity in a home without taking on debt. Unlike a home equity loan or a home equity line of credit, there are no monthly payments and no stated interest rate. That does not necessarily make it inexpensive: the investor’s share of the home’s value, along with fees, can end up costing more than loan interest. The CFPB found that in many contracts, the amount due at settlement increases by 19.5% to 22% a year during the early years. That is higher than most home-secured credit and somewhat below credit card rates. In return, the investor receives a portion of the home’s value later, usually when the property is sold.

With this kind of arrangement, the investment company receives a lien on the home. The homeowner gets a lump sum of cash in exchange for giving up a percentage of the property’s future value, which is typically repaid within a set period or, more commonly, when the home is sold.

During the agreement, the homeowner still must stay current on property taxes, homeowners’ insurance and other ownership costs. Proper maintenance may also be required. If the home is neglected, extra charges may apply at the end of the contract because deterioration can reduce the property’s value and the investor’s return.

Another way to think about a shared equity agreement is as an advance on future home appreciation. It can serve as an alternative to traditional equity borrowing, but it comes with its own set of trade-offs.

How does a home equity agreement work?

In a typical HEA, the investor provides a homeowner with a lump-sum payment in exchange for a share of the home’s future equity. An upfront transaction fee is usually charged as well, often calculated as a percentage of the total investment.

The agreement is usually structured as a lien on the property, giving the investor the right to part of the sale proceeds if the home is sold. The investor is paid according to an agreed-upon home appreciation rate, such as 10%. If the home declines in value, many contracts lower the repayment amount too, but the exact risk adjustment, fees and caps vary by company, so you could still owe more than you originally received.

If the home is not sold, many agreements run for 10 to 30 years. At the end of that period, the homeowner must buy out the investor. Depending on the company, this can be done by taking out a new loan, such as a home equity loan, or by paying the investor their share of the home’s value in cash.

It is important to distinguish a home equity agreement from products such as a home equity loan or HELOC. Those are loans that must be repaid over time with interest. A home equity agreement, by contrast, is a future payment obligation with no interest charge.

Home equity agreement pros and cons

As with any financial arrangement, home equity agreements have both benefits and risks. It is worth reviewing both sides carefully before signing a shared equity contract.

The pros of home equity agreements

Although these agreements are not the right fit for everyone, they can offer some meaningful advantages for homeowners.

Some of those advantages include:

No monthly payments or interest charges

Unlike a traditional loan or mortgage refinance, a home equity agreement does not require monthly payments and does not carry an interest rate. The amount owed at the end can still rise with your home’s value and the contract terms, but this may appeal to homeowners with limited cash flow or those who want to avoid more debt.

Lenient minimum credit score requirements

These agreements often have more flexible credit requirements than conventional borrowing options. That can make them attractive to homeowners who have real estate but do not qualify for traditional financing or favorable loan rates because of a lower credit score.

Flexibility in how you can use the funds

There are no restrictions on how the money must be spent. Homeowners may use the funds for home improvements, debt repayment or other needs.

The cons of a home equity agreement

Before giving up a share of future home equity, every homeowner should understand the possible downsides. These include:

Consequences of a lump sum payment

Home equity agreements usually provide cash in one lump sum. That payment is not earned income, but the arrangement can still affect the amount of capital gains tax owed when the home is sold. A tax professional should be consulted before signing.

It can get expensive, depending on your home’s amount of appreciation

If the property rises sharply in value, the total cost of the agreement can be high. The investor or company receives part of your home’s future value. If the home appreciates, you repay the original amount you received plus the investor’s share of the gain.

Before entering into this kind of deal, it is important to compare the policies of different companies and consider the direction of local housing market conditions. That can help you estimate how much you may owe when repayment comes due.

There are also upfront costs to keep in mind. Closing costs, including transaction or origination fees, can total thousands of dollars.

You’ll need to make a balloon payment

Whether you sell the house or reach the end of the agreement term, repayment usually comes as a single balloon payment. That may be manageable if you can use sale proceeds to cover the original investment plus the agreed share of appreciation, but if the term ends and you have not sold, you will need a large amount of cash on hand.

If you want to end the agreement early without selling the home, you will also need to make one large payment. That is known as a buyout, since you are purchasing the investor’s stake.

These possibilities should be considered carefully. Review your budget and decide how you would repay the investment if you remain in the home. You should also ask whether the company charges a prepayment penalty for ending the agreement early, and if so, how much it is.

No tax benefit

Interest on a traditional mortgage may be tax deductible. The same can be true of interest on a home equity loan if the money is used to build, renovate or improve the home securing the loan. A home equity agreement is not a loan, however, so there is no interest to deduct on a tax return.

Here is a simple example of how an HEA works:

Suppose your home is appraised at $250,000 and you sign an agreement with one of the home equity agreement companies. The company gives you $25,000 in exchange for 10% of your home’s appreciation. You can use the $25,000 however you choose.

If the house is sold for $250,000, the HEA provider is entitled to only $25,000. If the investor is not repaid, a penalty may apply.

If the home later rises in value to $300,000, the investor would receive 10% of the $50,000 increase, or an additional $5,000 on top of the original $25,000. If the agreement is repaid before any appreciation occurs, there is typically no added payment.

Many agreements are more expensive than this example suggests. The investor’s share of appreciation is often a multiple of the percentage invested. At Unison, for example, the investor percentage is typically four times the percentage invested. In that case, a 10% investment would entitle the investor to 40% of the $50,000 increase, or $20,000, in addition to the initial $25,000.

This is a simplified illustration. In many cases, companies apply a downward risk adjustment to the home’s value before deciding how much to invest. That adjustment is meant to reduce exposure to market swings and lowers the baseline value. Repayment is based on the home’s full appraised value, while the gain is calculated from the risk-adjusted value rather than the full appraisal. As a result, the investor’s share effectively increases.

Most HEAs are offered by companies that specialize in alternative lending. The products are not all alike, and there are important differences to consider before choosing a provider. Below is a look at four well-known home equity sharing companies, listed alphabetically.

Hometap

Hometap calls its equity agreements “home equity investments,” or HEIs. It offers investments in single-family homes, condos, vacation properties, rental properties, one- to four-unit multifamily homes and manufactured homes, and it requires a minimum FICO score of 585. The company is available in 26 states.

To qualify, homeowners must have at least 25% equity in the property, meaning the mortgage balance cannot exceed 75% of the home’s value. Hometap will invest up to 27% of the home’s total value, with a cap of $600,000.

Under its standard terms, Hometap receives the agreed-upon share of the home’s value when the property is sold, refinanced or the agreement is settled. Homeowners may pay off the investment at any point during the 10-year term, although appreciation in the home will affect the amount owed.

Point

Like Hometap, Point refers to its products as HEIs. Homeowners seeking equity through Point must have an appraised home value of at least $155,000, keep at least 20% equity after the funds are disbursed and live in one of the 30 states, or Washington, D.C., where the company operates.

The requirements are more flexible than those of a traditional loan. Credit is still reviewed, but Point may accept scores as low as 500. There may also be a waiting period for recent bankruptcies or foreclosures.

Point offers a 30-year term, giving homeowners more time to repay the investment, and its investment limit is up to $600,000. Homeowners can repay early without a prepayment penalty.

Unison

Unison is one of the earliest companies to offer home equity investments as an alternative to conventional equity products. It can buy up to 15% of a home’s current value in exchange for a share of future appreciation, allowing homeowners to access between $30,000 and $500,000.

After the home is appraised, Unison applies a 5% risk adjustment to account for possible valuation error. The agreement is based on that adjusted amount. Homeowners have up to 30 years to repay the original investment plus the agreed share of the home’s change in value.

Unison’s share of appreciation depends on the contract. The investor percentage is typically four times the amount invested. For example, if Unison invests 10% of the home’s value and the investor percentage is set at four times that amount, it would receive 40% of any future appreciation. To qualify, a minimum credit score of 620 is required. The company currently operates in 22 states and Washington, D.C.

Unlock

Unlock’s HEAs are available in 26 states to homeowners with a minimum credit score of 500, at least 30% home equity and a minimum home value of $175,000.

Unlike some providers, Unlock will invest in both owner-occupied primary homes and investment properties, though additional fees may apply for the latter. The minimum investment is $15,000 and the maximum is $500,000. Homeowners must keep the property maintained and remain current on property taxes, homeowners’ insurance and the first-lien mortgage.

How to find the best home equity agreement companies

The best home equity agreement company will depend on your situation. Before choosing one, do your research. Compare providers in your area to see which option best matches your goals, and pay close attention to the terms, upfront costs and penalties for early repayment.

It can also help to speak with a financial advisor, though that may add to your expenses.

When evaluating a home equity sharing program, look for a company with a strong reputation, a solid track record and generally positive customer reviews. Be sure to read the agreement carefully so you understand the full set of terms and obligations. If anything is unclear, ask the company representative to explain it.

Alternatives to home equity agreements

Home equity agreements have become more common as homeowners search for ways to access their property wealth during periods of higher interest rates. Still, they are not the only option. If you want to use your home equity for renovations, debt consolidation or unexpected costs, consider these alternatives:

Home equity loan

A home equity loan is a second mortgage that lets you borrow a lump sum against your equity and repay it in fixed installments over a set term. These loans usually have fixed rates, so the interest rate does not change during the life of the loan. That can be a good choice for homeowners who want a specific amount and predictable monthly payments.

Home equity line of credit (HELOC)

A HELOC works like a revolving credit line that you can draw from as needed, similar to a credit card. Interest is charged only on the amount you use, but most HELOCs have variable rates, which means monthly payments can change.

“HELOCs [can] be a helpful financial tool, but they aren’t for everyone,” says Jason Walter, certified public accountant and real estate agent at eXp Realty. Walter says they are often best for homeowners with substantial equity, steady income and the discipline not to treat their home like an ATM. For borrowers who want a fixed rate and set monthly payments, a home equity loan may be a better option.

Cash-out refinance

With a cash-out refinance, your current mortgage is replaced with a larger one, and you receive the difference in cash. This can offer a lower rate than some other borrowing options, but it often comes with higher upfront costs and resets the mortgage term, which may increase total interest paid over time.

How do these alternatives compare to home equity agreements?

Unlike loans or HELOCs, a home equity agreement does not create monthly debt. “It simply provides you with cash today in exchange for a share of your home’s future value,” says Eric Croak, certified financial planner and president of Croak Capital. Payments are not due until you sell or refinance, and the company shares in the home’s appreciation or depreciation.

Croak says HEAs can be especially useful for homeowners who have a lot of equity but limited cash. He also warns that in rapidly rising markets, owners may give up a significant portion of future gains.

No matter which option you choose, financial professionals stress the importance of understanding costs, repayment terms and risks. Comparing the options carefully can help you find the solution that best fits your financial goals.

Latest news in home equity

Home price growth has slowed and, in some areas, prices have fallen. As a result, homeowners have given up some of the large equity gains they built during the pandemic years.

Even so, property owners still have $11.7 trillion in tappable equity, according to Intercontinental Exchange’s August Mortgage Monitor report. That means they can access cash while keeping a 20% stake in the home. Equity remains a popular funding source for homeowners who want to pay off higher-interest debt, make repairs or cover other major expenses.

Although equity sharing is becoming more common, most people still rely on traditional ways of accessing equity, such as home equity loans. Cash-out refinancing has also drawn more attention, but many homeowners prefer HELOCs because they let them keep low mortgage rates locked in during the pandemic period. HELOC rates are variable, however, and have moved higher; after the Federal Reserve raised its target range to 3.75% to 4% in September and kept it there on Oct. 28, the prime rate stood at 7%.

Summary of Money’s What is a home equity agreement

A home equity agreement is an arrangement between a homeowner and an investment company that lets the homeowner access part of the equity in a home. In exchange for a lump sum of cash, the investor receives a lien and a claim to a share of the home’s future value.

This can be an alternative to traditional borrowing and may offer advantages such as no monthly payments, no interest charges, flexible use of funds and more lenient credit requirements.

Still, it is important to weigh the risks. Homeowners must be able to handle a large future payout, and the cost can rise significantly if the home appreciates. There are also upfront fees to consider.

Before agreeing to any home equity investment, compare the terms, fees and customer reviews of the companies you are considering so you understand the obligations and risks involved.

Understanding a Home Equity Agreement

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