American homeowners have seen their equity increase by $590 billion from the first quarter of 2019 to the first quarter of 2020. The coronavirus pandemic has increased unemployment, and many struggled to make monthly payments. However, prices have continued to rise so home equity has increased since March.
Of course, higher home prices doesn’t help you if you have a mortgage and you’re struggling to make ends meet. So, it’s not surprising that millions of Americans have tried to tap into their home equity.
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There are many ways to tap into your home equity. You have probably heard of home equity loans, home equity lines of credit (HELOCs), cash-out mortgage refinancing, and reverse mortgages. But there is a fifth option that is becoming increasingly popular. We are referring to home equity investments, also known as shared equity agreements.
What are home equity investments?
Shared equity agreements give you the option to get paid now for the equity you’ve accumulated in your property—without getting into debt. There are no monthly payments or interest rates. In exchange, you sell a share of your home’s future value to an investor. When you sell your home or the investment contract ends (typically 10 to 30 years), you return the initial investment plus a share of the home’s appreciation.
One way of looking at it is to view your home as a business. In that scenario, a home equity investment is like selling a stake of your company to a silent partner. The silent partner has little to no say in how you manage your business, but they do receive a share of the profits.
What types of home equity investments are there?
There are two main types: share of home value and share of appreciation.
The share of appreciation model requires homeowners to return the full investment when they sell the house (or the contract term ends) plus an agreed percentage of the increase in the value of the property. The share of appreciation model is used by most companies, such as Point, Unison, and Noah.
In the share of home value model, the investor receives a fixed percentage of the home’s value at the end of the home equity investment’s term. Investors like Hometap use the share of home value model.
How much does a home equity investment cost the homeowner?
It is impossible to calculate precisely how much a home equity investment will cost because nobody knows how the housing market will perform. However, we can get a good idea of the potential cost by looking at a couple of scenarios.
To start with, let’s use the average annual home appreciation rate, which is around 5 percent a year. In that case, a $50,000 home equity investment on a $500,000 home would cost $136,013 after 10 years. That is the equivalent of a 24.9% fixed-rate mortgage if you could find a lender that will give you $50,000 and charge no monthly payments for 10 years.
On the other hand, if your home does not increase in value after 10 years, you could get the equivalent of a 0% loan.
Who is a good fit for a home equity investment?
Home equity investments are a good option for people who need to tap into their home equity, but either don’t want to or can’t afford to get further into debt.
Let’s say you need cash now but can’t afford additional monthly payments. Maybe you need to finance your child’s education or consolidate high-interest debt, but you want to avoid the interest and monthly payments of student loans and debt consolidation loans. A home equity investment can provide the money you need without increasing your debt.
On the flip side, you probably want to avoid home equity investments if you plan to stay in your home for more than 10 years or if you don’t have enough equity in your home. It varies depending on the investor, but you typically need to have a loan-to-value ratio of 75 percent or less to qualify for a home equity investment.
If you are looking to tap into your home equity and you have excellent credit and a low debt-to-income ratio, consider a mortgage refinance or a HELOC. However, there is a new option for homeowners that want to avoid debt and don’t qualify for traditional home equity financing.