What’s a Home Equity Investment, and Is It Ever a Good Idea?
While owning your own home isn’t exactly the “easy button” for wealth-building it’s sometimes made out to be, it’s still a reliable way to build your net worth over the long term. Aside from the emotional aspects of having a piece of property to call your own, a house represents a significant asset–for most people, the largest asset they will ever own.
As you pay off your mortgage, you gain more equity in the property–the percentage of the house you own outright. And that’s good news for most people, because your house is also probably simultaneously appreciating in value, despite the occasional market correction. For example, between 2009 and 2020, home values increased a little more than 40%. Which is good news, because most of us have almost no savings at all–more than a third of Americans couldn’t come up with $400 cash in an emergency, and most people have less than $5,000 in savings. Tapping into home equity is a life-saving economic buffer.
But getting to that equity can be a challenge. Typically, you get equity by opening a home equity line of credit (HELOC), getting a home equity loan, or arranging for a cash-out refinancing of the home. But if you have bad credit or you don’t have enough cash on hand to handle closing costs and the monthly payments those products require, you could be prevented from accessing the value of your own property. The good news is there might be one more option: A home equity investment (HEI).
What is an HEI?
A home equity investment is a deal wherein an investor loans you a portion of your equity in exchange for a percentage of your home’s future value. These come in two basic forms:
Equity sharing, in which the investor gets a minority ownership stake in your home, which rises in value as the property appreciates. Shared appreciation, in which the investor buys a percentage of the home’s future appreciation–the future rise in the value of the property.
In both cases, there is a term on the loan (typically 10-30 years). When the term ends, you’re obligated to pay back both the amount of the initial loan plus the added value of the property. For example, let’s say you own a house currently worth $250,000, and you’ve built up $100,000 in equity. An investor provides you a $50,000 loan in exchange for 25% of your home’s appreciation, with a 10-year term. After 10 years, your home is worth about $370,000, so it gained about $120,000 in appreciated value. You now owe your lender $80,000–the original $50,000 loan plus one-fourth of the appreciation.
If you have an equity sharing arrangement, you’d get the $50,000 loan and the lender would get a 25% stake in the property. When you sell at $370,000 ten years later, depending on the specific language of your agreement, they could get $92,500–one-quarter of the appreciation of your property’s value–back on the deal. Of course, if your home appreciates less–or depreciates–you might owe the lender much, much less.
HEIs will vary between lenders, so these numbers are just examples. If you think this might be a good option, be sure to review any agreement in detail to understand exactly how that specific loan will work–because there are serious pros and cons to these type of loans.
The pros and cons of a home equity investment
There are some good reasons an HEI might be a good product for you:
You’re cash poor. HELOCs and refinancing are typically better options for tapping equity, but they involve paying costs on the loan and making monthly payments. If you don’t think you can handle monthly payments, HEIs don’t require them–however, many HEIs do have origination costs you might have to pay. You have bad credit. If your credit score means you can’t qualify for most traditional home equity loan products, HEIs are often your sole option for pulling equity out of your home. Since they rely on the value of your property and not your credit-worthiness for making payments, your credit score is much less important. You don’t want to go into further debt. HEIs aren’t debt, they’re investments. If you don’t want to increase your debt burdens, these products do the job.
However, there are some downsides to consider:
They’re balloon loans. HEI arrangements get you cash without the burden of regular repayments, but everything comes due at the end of the term. In the example offered above, after 10 years you’ll owe your lender $80,000, which has to be paid in one lump. If you haven’t planned ahead, you might find yourself forced to sell your home even if you don’t want to. They can cost more. If your home gains a lot of value, you can wind up paying a lot more for accessing your equity than you would with a home equity loan of some sort. On the other hand, if your home decreases in value, you might have to pay back less than the original value of the loan. Your mortgage holder might forbid it. Some mortgages forbid selling off portions of your equity, so you might run into legal trouble if you try to arrange a home equity investment. Check your mortgage documents and possibly a lawyer before considering this option.
Over time, your home comes to represent a huge proportion of your wealth–but it’s trapped there in house form, which is difficult to lug to the store and spend. If you can’t get at your equity for some reason, a home equity investment might be a good option for you–just make sure you understand exactly what you’re getting yourself into.
