By John Manning, International Banker
For many of us, the largest single component of our accumulated wealth is represented by the value of our home. And yet, until very recently, we have been unable to access that wealth, which in many cases can be substantial. This has rendered a number of homeowners in a permanent financial state known commonly as “house-rich, cash-poor”, such that their wealth is tied up in the values of their homes, and they have access to limited liquidity.
“A lot of people are house-rich but cash-poor,” Ivy Zelman, chief executive of real-estate consultant Zelman & Associates, told the Wall Street Journal in September 2020. “If they bought in the last two or three years, even if they bought five months ago, they have equity.” Having plenty of home equity but struggling to make payments, according to Zelman, means that many homeowners could be forced to sell their homes while prices are high and exit homeownership with a cash cushion. While the pandemic has certainly helped delay many problems stemming from homeowner defaults, such as property foreclosures, it will eventually fail to conceal that being cash-poor is a serious problem for many homeowners.
Until just a few years ago, the only borrowing solutions available to cash-strapped homeowners looking to access their home equity were debt products. But thanks to the recent proliferation of shared home-equity agreements, the ability to raise funds from the value of one’s home without incurring additional debt has become distinctly easier.
Much in the same way that companies have been able to raise funds by issuing equity through shares to investors, homeowners can now enter shared home-equity agreements in order to similarly issue part of the equity in their homes to willing investors and thus raise money. For those homeowners who have sufficient equity accumulated in their properties, shared home-equity agreements provide them with opportunities to access liquidity without incurring new debt. “We provide homeowners with a smart new loan alternative for tapping into their home equity without taking on debt,” explains Hometap, one of the leading specialists in the shared home-equity space.
Typically, investors will buy a portion of the homeowner’s equity, providing a lump-sum cash payment to the owner, usually up to $350,000, for partial ownership of the home. In return, the investors receive the lump sum plus a specified percentage of any future appreciation (or depreciation) in the home’s value during the life of the contract, typically between 10 and 30 years. As such, the investor would participate in such a contract only if the home’s value is likely to appreciate in the future. “We invest alongside you, providing cash today in exchange for a share in your home’s future value. Settle any time within 10 years,” Hometap states.
For the homeowner, meanwhile, the shared home-equity agreement does not require a monthly payment to be made to the investor, unlike debt products such as mortgages and home equity lines of credit (HELOCs). Instead, the amount the investor receives is based on the value of the home whenever the contract is settled, either at the end of the term or beforehand. “Unlike a lender, we receive no monthly payments or guaranteed return on the money we’ve invested. For some, taking an equity investment can be an intelligent way to fund the opportunities and needs that come up in life while eliminating the ‘debt stress’ of increased monthly payments,” according to Hometap. And the homeowner continues to live in and maintain majority ownership over the home. The homeowner typically uses savings, refinancing or proceeds from selling the property to fulfil this repayment.
As such, the investor is repaid by the homeowner before or at the end of the term of the shared equity agreement, with the amount owed being calculated based on the value of the property. “If the home appreciates, the investor and the occupier share the profits. If the home value drops, the investor will lose some or all of his/her investment,” observed real-estate legal firm Sirkin-Law.
Can any homeowner qualify for access to shared home-equity agreements? Not quite. Point, for instance, has three key eligibility criteria, as explained on its website:
- Homeowners must own their homes in an eligible area, and the property value must be above $200,000.
- Homeowners must retain at least 30 percent of the equity in their homes after Point’s investment, if not more in certain situations.
- Homeowners must also meet minimum credit-score and maximum indebtedness thresholds, although these would typically be less stringent than more traditional home-equity options.
“For most homeowners, this is an alternative to a HELOC or home equity loan,” Point co-founder Eoin Matthews explained to US personal-finance company NerdWallet in 2019. “We are able to underwrite to more forgiving standards, which means homeowners that might have substantial equity in their home, but don’t qualify for a HELOC or home equity loan”, can qualify for a shared home-equity agreement.
And with home prices having consistently risen over the last decade in the United States, homeowner equity across the country stands at record highs at present, which in turn means that more homeowners than ever are eligible to participate in shared home-equity agreements. According to ATTOM, a provider of US property data, 34.4 percent of mortgaged residential properties in the country were considered equity-rich in the second quarter, in that the combined estimated amount of loans secured by those properties was no more than 50 percent. The portion of mortgaged homes that were equity-rich during the quarter—one in three—was also up from the 31.2 percent recorded in the first quarter and from the 27.5 percent registered a year earlier. “The huge home-price jumps over the past year that helped millions of sellers earn big profits also kicked in big-time during the second quarter for other owners who saw their typical equity improve more than at any time in the last two years,” said Todd Teta, ATTOM’s chief product officer. “Instead of the virus pandemic harming homeowners, it’s helped create conditions that have boosted the balance sheets of households all across the country.”
And in terms of the liquidity that shared home-equity contracts unlock, cash-poor homeowners can use these often much-needed funds to achieve a much greater degree of financial freedom in the near term. According to Noah, the shared equity agreement originator, some popular ways homeowners use the proceeds from their contracts include paying down outstanding debts (including existing mortgages), completing home renovations, adding to savings pots and building businesses.
Of course, the funds raised must be paid back to investors at some point during the life of the contract. For homeowners, the major downside is that they will be relinquishing a portion of the future price appreciation of their homes that could materialise. Such an amount could well end up being sizeable, particularly if the homeowner stays in the home for the entire duration of the agreement—possibly as long as 30 years.
And should the value of the home increase substantially during this time, the amount owed could potentially balloon to an unmanageable level. There is thus a chance that homeowners could default on their repayment obligations, which presents a very real risk to investors. With such tight eligibility requirements for homeowners, however, particularly the requirement of having around 30-percent equity in their homes as a minimum before entering into the contract, the likelihood of default is kept to a minimum.
There are certainly risks the homeowner and investor face when entering into a shared home-equity agreement of which both parties ought to be aware. Nonetheless, the popularity of such contracts over the last few years has proven that home-equity contracts can be hugely beneficial to both parties. They provide fast access to liquidity for homeowners, which is certainly much sought after during these challenging times for the global economy; and they also provide exposure to the residential real-estate market for investors, which is one of the few markets that has offered consistent annual gains during the last few years, including the period since the onset of the pandemic.