In today’s post I want to discuss a new product that is being pushed out, why this home equity product is a terrible idea and also why something like this came about.
What is Home Equity Sharing?
Home equity sharing allows homeowners to access cash in exchange for giving a company minority ownership in the home. So, it’s probably easier to give an example. John, a homeowner, has lived in his home for 10 years. He has a fair amount of home equity but doesn’t qualify for a home equity loan due to his credit. So, he decides to enter a Home Equity agreement.
What the agreement will do is allow the company John signs the agreement with to access future appreciation in the home. In return, John will get some upfront cash with no interest rate. Sticking with our example, John received $50,000 and at the time his home is worth $500,000. A typical arrangement is that homeowners must pay 65% of any future appreciation back to the other party. So, if in ten years, John then sells his home for 600,000, he would owe $65,000(65% of the $100,000) and the $50,000 he originally got from the company for a grand total of $115,000($65,000+$50,000). In a different scenario, if the home was worth only $510,000 in ten years, then John would owe $6,500(65% of the $10,000) and the original $50,000 that he got.
So, we can get a general sense how these arrangements work. Essentially, instead of paying interest you are paying back the company with future appreciation from the home. And the value you payback the company can be huge; sometimes twice the amount borrowed or more.
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One thing to point out to is that these companies will typically give your home value a discount in order to protect all parties. For example, a home valued at $500,000 might be listed in the contract as $470,000. This protects the buyer if the home value drops but does give the other side more potential to gain profit. For example, in the example earlier if the value of the home goes up to 600,000, then the company would get $84,500(65% *130,000) instead of 65,000.
Why is Home Equity sharing a terrible idea?
There’s quite a number of reasons, in my opinion, that Home Equity sharing is bad. First, it tends to be marketed toward individuals who have a lot of equity in their home, but don’t have a lot of cash. Sometimes these people are not educated financially and are not aware of the consequences. A second reason is the amount you have to pay back is in a lump sum, almost like a balloon loan. It’s also probably the case that many of the people that sign up for these agreements are not aware of just how much they might have to pay back. A third reason is the agreements take away the home equity a person should be building. This can be massive amounts for people. There are many homes that have doubled in value around the US the last few years. Imagine if you got into one of these agreements and your home doubled from 400,000 to 800,000. With one of these agreements, you could easily lose 300,000 or more of equity that you could have used for retirement or maybe another home.
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Why did Home Equity Sharing come about?
This product really came about with the ever-increasing values in the Home Market. These companies looked at the wealth consumers were making from their homes and knew they had to get in on the action. The entire business model is based on home prices going up, and the more they increase the better for these companies. Of course, if something changes in the home market and prices stay flat year over year, it will pretty much destroy these businesses.
Is there much demand for these products?
Not right now, not a ton. They are still considered alternative financing options. But they are picking up in popularity. And this is the scary part right here when you think about it. People are having to resort to signing one of these agreements to have adequate cash. It’s something that, in my opinion, most people wouldn’t even have considered ten years ago.
We should expect alternate financing options like this to continue to grow. One other option, I’ll be doing soon is “Buy Now, Pay Later”. Most people are familiar with this, less are familiar with home equity sharing.
What are your thoughts on Home Equity Sharing?
