The value of our property is the single largest component of our total wealth for many of us. Yet, until recently, we were unable to gain access to that money, which can be substantial in many cases. As a result, many homeowners have found themselves in a perennial financial situation known as “house-rich, cash-poor,” in which their wealth is tied to the value of their properties and they have little liquidity.
In September 2020, Ivy Zelman, CEO of real estate advisory firm Zelman & Associates, told the Wall Street Journal, “Many people are property-rich but cash-strapped.” “If they bought within the last two or three years, or even if they bought five months ago, they have equity.” Needing a big amount of home equity but still having to make payments, according to Zelman, means that many homeowners will be forced to sell their homes for a profit and exit homeownership with a cash cushion. While the pandemic has helped to postpone many of the issues associated with household defaults, such as property foreclosures, it will eventually fail to hide the fact that many homeowners are cash-strapped.
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Until recently, loan instruments were the only available financing choices for cash-strapped homeowners looking to access their home equity. However, with the recent growth of shared home equity agreements, raising funds from the value of one’s home without incurring new debt has become substantially easier.
Homeowners can now participate in shared home equity agreements to sell a portion of the equity in their homes to willing investors and therefore raise money, similar to how businesses raise money by issuing equity in the form of shares to investors. Shared home equity agreements allow homeowners who have built up enough equity in their homes to access funds without taking on further debt. Hometap, a pioneer in the shared home equity area, claims, “We give homeowners with a clever new financing choice for accessing their home equity without incurring debt.”
Typically, investors will buy a portion of a homeowner’s equity and pay the owner a big sum of money, up to $350,000, in exchange for a portion of the home. The investors receive the lump sum payment plus a percentage of any future appreciation (or depreciation) in the home’s value over the length of the contract, which is typically ten to thirty years. As a result, the investor would only sign such a contract if he or she feels the home’s value will increase in the future. “We make an investment with you, offering you money in exchange for a share of your home’s future value. “You have the option to settle at any time in the next ten years,” Hometap says.
The shared home equity agreement, unlike debt instruments such as mortgages and home equity lines of credit, does not require the homeowner to make a monthly payment to the investor (HELOCs). Rather, the investor is compensated based on the home’s market value at the moment the contract is concluded, either at the end of the term or ahead of time. “We do not receive monthly payments or a guaranteed rate of return on our investment, unlike a lender.”
According to Hometap, “for some, investing in equity might be a wise way to support life’s chances and necessities while avoiding the ‘debt load’ connected with larger monthly payments.” In addition, the homeowner continues to live in the house and owns the majority of the property. The homeowner usually pays off the loan using savings, refinancing, or proceeds from the sale of the home.
As a result, the homeowner repays the investor either before or after the end of the shared equity agreement, with the amount owed determined by the property’s value. “Both the investor and the occupant benefit if the residence appreciates in value. “If the value of the home drops, the investor may lose some or all of their investment,” said Sirkin-Legal, a real estate law firm.
Is it possible for a homeowner to qualify for a shared home equity agreement regardless of their financial situation? No, not at all. Point, for example, has three key eligibility criteria, as outlined on their website:
Homeowners must live in a designated area and own a property worth more than $200,000.
Following Point’s investment, homeowners must keep at least 30% of their home’s equity, if not more in some cases.
Homeowners must also meet minimal credit score and debt-to-income standards, but these are frequently less stringent than for traditional home equity loans.
In 2019, Eoin Matthews, co-founder of Point, told US personal finance website NerdWallet, “For the majority of homeowners, this is a realistic alternative to a HELOC or home equity loan.” “Homeowners who have large equity in their property but may not qualify for a HELOC or home equity loan” may qualify for a shared home equity agreement because “we can underwrite to more relaxed requirements.”
And, because home values have risen steadily in the United States over the previous decade, homeowner equity is currently at historic highs across the country, allowing more homeowners than ever to engage in shared home equity arrangements. According to ATTOM, a property data provider in the United States, in the second quarter, 34.4 percent of mortgaged residential properties in the country were classed as equity-rich, meaning that the total estimated value of loans secured by those properties did not surpass 50%.
During the quarter, one in every three mortgaged homes had positive equity, up from 31.2 percent in the first quarter and 27.5 percent a year ago. “The massive increases in home prices that enabled millions of sellers to earn significant profits over the last year also kicked in big-time during the second quarter for other owners, who saw their typical equity improve more than at any point in the last two years,” said Todd Teta, ATTOM’s chief product officer. “Rather from causing harm to homeowners, the viral pandemic has contributed in the formation of conditions that have bolstered household balance sheets across the country.”
In terms of liquidity, cash-strapped homeowners can use these frequently-needed funds to reach a substantially better level of financial independence in the near future thanks to shared home equity arrangements. Homeowners commonly utilize the gains from their contracts to pay off outstanding debts (including current mortgages), finish house renovations, supplement savings accounts, and establish businesses, according to Noah, the creator of shared equity agreements.
Naturally, the funds raised must be reimbursed to investors at some point during the term of the contract. The most significant downside for homeowners is that they will lose a portion of any future appreciation in their home’s value. Such a price can quickly add up, especially if the homeowner stays in the house for the duration of the contract, which might be up to 30 years.
In addition, if the home’s value rises dramatically during this time, the debt may balloon to an unsustainable level. As a result, it’s possible that homeowners will default on their mortgage payments, creating a major risk to investors. The likelihood of default is reduced by imposing such tight qualifying limitations on homeowners, particularly the requirement that they have at least 30% equity in their homes prior to entering into the contract.
Before engaging in a shared home equity arrangement, both the homeowner and the investor should be informed of the risks. Nonetheless, the rise in popularity of such contracts in recent years has shown that they can benefit both parties. They give homeowners immediate access to liquidity, which is important during these trying times for the global economy, and they give investors exposure to the residential real estate market, which is one of the few that has delivered consistent annual gains over the last few years, including since the pandemic began.