Understanding home equity investments and how they impact your homeownership
Choosing a loan that suits your needs comes with many considerations. Many homeowners now have a wealth of options at their fingertips, from home equity lines of credit (HELOCs) to cash-out refinance and reverse mortgages.
Your options vary slightly depending on your need, what you qualify for and your long term goals. Depending on those variables, you may qualify for some financial solutions and not for others.
At the same time, not all products are created equal. While you have the options available to you, some can be quite predatory and leave you, the borrower, at a disadvantage.
One of the most common options for unlocking your home equity is a home equity investment (HEI). Let's dive into this type of loan. Here's what you can expect in this blog:
What is a home equity investment?
Also known as co-investing or home equity sharing, an HEI is a way to tap into your home equity through an alternative equity sharing agreement.
These arrangements typically allow home equity co-investment companies like Noah, Point, Unison, Hometap and Unlock to buy up to $550k or more in equity from homeowners. Once approved, they provide homeowners access to a lump sum of cash in exchange for a portion of the home’s future appreciation.
How does it work?
Financial solutions such as home equity co-investments offer an alternative to home equity loans by providing homeowners a way of selling their home equity instead. They receive cash upfront in exchange for a portion of their hard-earned home equity.
At the end of the term, or when the house is sold, a home equity investment can vary depending on the firm offering the product. In some instances, a homeowner would owe the original principal plus a 3-4x share in the appreciation of the home, and in some instances, a homeowner would owe 1.5-2.0x the percentage of funds received.
For example, if you receive 10% of your home value, you would owe 15% of your home value at the time of sale. In some cases, certain HEI firms will discount the home’s value at inception.
How do I qualify for a home equity co-investment?
Each co-investing company comes with its specifications and criteria. Depending on the lender, there are minimum FICO requirements, most expecting the homeowner to have a score of 500+.
This is a lower score than what banks seek as a minimum (680). It is also lower than what most lenders look for in other financial products, including mortgages, refinances, cash-out refinances, and home equity lines of credit (HELOCs). This could be ideal for your specific needs if you do not have a healthy credit score.
You must also fully own a specific percentage of your home to qualify, which is not ideal for all borrowers. This means that you should have built a considerable amount of equity in your home. Some co-investing companies will lend to borrowers whose mortgage has a loan-to-value ratio (LTV) of up to 75%. Others can go up to as high as 90% LTV.
Another criterion is the type of house you own, depending on whether this is your primary or secondary residence and what type of dwelling it is (single-family, condos, etc.). An appraiser will assess the value of the house.
A home equity investment is a lien, similar to a mortgage, but it is backed by an option agreement, not a note (which comes with a mortgage). Homeowners then take the agreed-upon lump sum amount. When the time is right, they sell their home or buy back their shares, paying the co-investment company a predetermined buyback rate.
What are the rates and terms for a home equity co-investment?
These rates can vary based on the amount of home equity you sell. For example, you may sell 10% of your home’s value for 15% of the change in value, up or down. If your house goes up 5%, then the cost of that would be the equivalent of 20% interest in a year.
Most companies charge a 3 - 5% transaction fee for new co-investments. Terms vary based on the firm but typically can last between 10 - 30 years.
Which companies provide home equity co-investments?
There are many companies available that offer loan alternatives via home equity investments. Here are a few of the more prominent ones and their rates:
Unison: Homeowners who have built up enough equity in their home can convert up to 17.5% of 95% of the home’s value to a maximum of $500,000.
Unison’s product comes with a 30-year term, which can end sooner if the homeowner sells the home earlier.
At that point, the homeowner must pay off the cash that Unison invested or sell the house. If there’s a home sale, the homeowner is obligated to share any profit with Unison. If the property is not properly maintained through the term, the amount you owe could increase substantially.
Point offers a 30 year term and flexibility to choose when you pay them back or buy your equity back. Depending on your equity, they offer you anything between $25,000 to $500,000 in funds. In a typical agreement with Point, you can exchange 10% of up to 80% of your current home value (cash you receive upfront) for 30% of the change in price from 80% of the value.
There are no monthly payments and no interest charged. Instead, Point invests in the home and takes a portion of the home’s equity. Meaning that any change in the home’s value over the term, any increases or losses, will be shared with Point. If the home's value rises, they share the overall gains when the term ends, you sell your home or refinance. If the value drops, Point also shares in the losses.
Hometap gives you 10% of your home value in exchange for 15% of your home. In a typical agreement, Hometap can exchange 10% of your current home value (cash you receive upfront) for 15% of the home’s future value (Hometap’s equity share).
The company helps homeowners access up to 30% of their home’s value, and funds up to $600,000, but it cannot be used toward the down payment of the property that secures the loan.
Similar to most HEIs, Hometap earns money when your home sees gains in the market. Upon term end, they company receives a portion of the home's higher, appreciated value. If your home depreciates in value, they share in the losses.
Unlock funds up to $500,000, or up to 43.5% of your home’s appraised value. They have a maximum loan-to-value of 85%. In a typical agreement with Unlock, you can exchange 10% of your current home value (cash you receive upfront) for 16% of the home’s future value (Unlock’s equity share).
When you sign a home equity sharing contract with Unlock, you are agreeing to receive cash now in exchange for a share of equity in your home. This does not mean Unlock will keep that equity forever. Instead, homeowners have 10 years to buy out its position or stake in your home, or you will have to sell your home at the end of the term to pay them back. Once you sell the home, you’ll receive your portion of the sale price, minus Unlock’s agreed-upon equity share and any outstanding mortgage debt.
The pros of home equity investments
While it may sound like a loan, there are some crucial nuances to consider. Let’s dive into some of the pros and cons of using a home equity co-investment to access cash.
- These investments offer terms of up to 30 years, and homeowners do not have to pay off their current mortgage to qualify.
- Unlike a traditional mortgage, if your home value drops through the term, you are still expected to pay the entire loan amount. With home equity co-investments, if your home depreciates, the co-investor could end up taking a loss depending on the amount borrowed.
- No monthly payments.
- Suppose your credit score disqualifies you for other loans. In that case, home equity co-investment may be easier for you to qualify for.
The cons of selling your home equity
Some risks come with selling parts of your home off. Here are some of the more considerable disadvantages to selling home equity.
- There are some fees associated with home equity investments; some of them are upfront.
- A home equity investment is a new product that many lenders do not understand, as a result it can be very difficult to refinance your first mortgage when you would like to.
- Every house must undergo an inspection and appraisal, which sets the basis for your home’s worth. This comes out of pocket.
- Because of the multiplier effect that these investments come with, your equity will erode over time faster than with any other debt product.
- These loan alternatives are not located across all of the US. Availability varies by region.
- Like a reverse mortgage, if the homeowner dies and the home is passed to their estate, the estate will have to abide by the terms of the equity investment agreement. Any heirs must then split proceeds from any gains (or share in any losses).
- If you’re expecting the value of your home to increase over time, using your home’s current value against its future value can help you unlock cash, at a cost. If your home value increases by 10%, you owe up to 40% back, adding to your overall debt load.
For example, you’re a homeowner who owns a $1m home and owes $700k on an existing mortgage. To access cash, you choose to take a $100k home equity investment. If your home goes up 5% a year every year for 5 years, at the end of the 5 years, your home will be worth $1.27m, and you will owe a significant amount, not only to the existing mortgage (up to around $645,000), but now to the HEI company.
At this rate of appreciation, you could owe the HEI around $208k. In this scenario, your total debt load is $853k vs. $800k at inception.
Should I get a home equity co-investment?
While it allows quick access to cash, co-investing can impact your financial trajectory. Over the long run, equity sharing can cost more than you think and leave you with less in your pocket when you sell the home.
Home co-investments are typically classified as a second lien. In the event of a foreclosure, it is repaid after the primary mortgage is paid. If you choose to sell your home and the proceeds do not cover both the outstanding mortgage and the balance owing to the co-investing firm, the homeowner will have to make up the difference out of their pocket.
If you find yourself cash-strapped later down the road and have agreed to a home equity co-investing agreement, you may end up having to buy that equity back. Meaning you may need to take out a more traditional home loan or a line of credit to pay out of your position.
If your home appreciation is significant. It will eat away at most of your equity. This is due to the 4x share in equity that many of these HEI companies bake into the commitment. Meaning that if your home goes from $1m to $2m, and the home equity investment was $100k, it could be $500k when it's $2mm, on top of your original mortgage, leading to even more debt in the long run.
How Fraction is different from home equity co-investments
The Fraction Mortgage is a first-lien open line of credit that offers many of the benefits of traditional HELOCs with added flexibility. Monthly payments are no required, and our interest rates adjust to the appreciation of your home.
Fraction offers two term options, a 5 and 10 year term with optional monthly payments*. Our rates are variable and when you are ready to repay your loan, the amount you pay back – with interest, is based on the appreciated value of your home, based on the Zillow Home Value Index (ZHVI) by zip code.
The rates for a Fraction Mortgage are as follows:
5 year: 3.74% APR*
10 year: 4.44% APR*
5 year: 9.38% APR*
10 year: 11.57% APR*