What is a home equity investment?

A home equity investment offers you money upfront in exchange for a percentage of your home's future value. It's a complex, modern product with a lot of moving parts. They could be useful tools for some homeowners, but only if you have a thorough understanding of the pros and cons.

What is a home equity investment?

Home equity investments provide you with money today in exchange for a percentage of your home's future value. They are not classified as home loans, and they're not regulated like mortgages. This sort of arrangement has many names, including:

• Shared equity contract/agreement/arrangement

• Shared equity mortgage

• Home equity investment loan, or HEI

These products work very differently from traditional home equity financing. 

• Home equity investment providers aren't usually considered lenders. They call themselves "investors." As a result, you don't get the same consumer protections with a home equity investment that you do with a mortgage.

• Equity investment companies don't call their product a loan. They call it a "share" or "investment." Instead of lending you money, they invest in your property.

• Generally, you pay no interest. And you're not typically required to make monthly payments.

• The balance is due in full at the end of the loan term, or sooner if you sell the home.

• Terms are usually 10 years but could be longer.

• Your credit standing is much less important than with traditional home equity financing. Some providers accept credit scores down to 500, and your debt-to-income ratio often doesn't matter.

How does a home equity investment work?

While these are not standard home equity products such as a HELOC or home equity loan, many of these arrangements have some features in common with them. 

With an HEI, you typically get a lump sum amount at closing. At the end of your term, or sooner if you sell the property or terminate your arrangement, you pay the provider a percentage, or share, of your property's appraised value.

Step 1: You get cash upfront

The amount you may receive depends on your home's current value, how much equity you already have, and additional criteria. Eligibility requirements vary a lot between companies.

Typically, the investor may advance you up to 25% of your current property value for a 10-year term. You'll likely pay closing costs, plus an origination fee of 3% to 5% of the amount you're approved for. Let's assume you want to borrow 10% of your property’s value of $400,000. You could receive $40,000, minus your closing costs.

Step 2: You repay later based on your home's value

You typically don't make monthly payments with a home equity investment. Instead, repayment is usually triggered by selling your home, refinancing, or reaching the end of the agreement's term. You'll typically pay a percentage of your property's value at the time.

The split percentage varies by provider, but repayment of 20% of your equity is not uncommon for a 10% advance for 10 years. Your paperwork should spell out the exact split and how long the agreement is in place.

Here's a simplified example of what repayment might look like in 10 years if your home appreciates at a 4% annual rate. 

In this example, what you pay is very close to what you'd owe if you borrowed $40,000 at an 11% rate for 10 years with no payments. This is a hypothetical illustration for comparative purposes only. Traditional loan rates vary based on creditworthiness, equity, and market conditions. Terms and conditions apply. 

Is 11% a good rate for a home equity loan? That depends on what traditional lenders would offer you given your credit rating and the amount of existing equity in your home.

Step 3: Fees and contract terms shape the total cost

Costs can include upfront fees, appraisal costs, and administration or servicing fees, though these vary by provider. Many contracts also include caps, floors, or minimum return provisions. Reading those details carefully matters, because the total cost of a home equity investment can be difficult to estimate until you know how much your home is worth at payoff time.

Read your documents very carefully

Provisions of an equity investment—how appreciation is calculated, how much you get upfront and how much you pay back—are not standardized. Many providers, for instance, just require a simple split of your home value. 

Others mandate repayment of the initial amount borrowed plus a percentage of the amount your property value increased. And these providers usually discount the appraised value at the beginning, which means you owe them a percentage even if your property value doesn't go up at all. 

If your home does increase in value, you pay even more.

Note that you don't get the same disclosures and protections that you do with a mortgage. The Consumer Financial Protection Bureau says, "Home equity contracts are complex financial contracts, and the current lack of standardized disclosures can make it difficult to understand them or compare them to other options."

In other words, it may be wise to get professional help understanding how it all works.

Pros and cons of a home equity investment

Potential benefits

• You receive a lump sum without adding a monthly loan payment to your budget.

• Approval may be more accessible for homeowners with low credit scores or high debt-to-income ratios.

• Can be cheaper than traditional home equity financing, but only if the property doesn't appreciate in value much.

Potential drawbacks

• At repayment time, you have to come up with what could be a large sum. If you can’t, you may be forced to sell your home.

• Total cost can be hard to estimate upfront, because it depends on your home's future value.

• Contract terms can be confusing, and standard mortgage consumer protections don't apply. There may be restrictions around home improvements, occupancy, or appraisals.

• If you terminate your contract early or your home appreciates a lot, your costs can be much higher than those for a traditional loan. 

Is a home equity investment a good idea?

Rarely. A home equity investment may be worth exploring if:

• You plan to stay in your home long enough. Terminating the agreement early can increase your costs.

• You're confident you understand how the payoff will be calculated.

• You've run scenarios for different home value outcomes.

• You don't have safer options to get the funds you need.

Be more cautious if:

• You may sell or refinance in the near term.

• Your home is in a market with strong appreciation (the more its value rises, the more you owe).

• The contract terms are difficult to understand or explain.

A home equity investment could make sense for some homeowners, but only after a thorough review of the agreement and a careful comparison with alternatives.

What to check before you sign a home equity investment agreement

• How payoff is calculated under different rates of home appreciation

• All fees (upfront and at payoff)

• Term length and repayment triggers (sale, refinance, end of term)

• Rules for home improvements, appraisals, and valuations

• What happens if your home value goes down

• Any restrictions on occupancy, renting, or adding liens 

• Whether you can buy out early, and how a buyout price is set

Alternatives to a home equity investment

If a home equity investment doesn't feel like the right fit, other options may work for your goals and budget.

• A home equity line of credit gives you a revolving credit line from which you can draw, repay, and draw again up to your limit over and over during the draw period.

• A home equity loan provides a lump sum, typically with a fixed payment schedule and terms of up to 30 years.

• A cash-out refinance replaces your existing mortgage with a new, larger one, giving you the difference in cash.

Comparing total costs and time involved across these options is an important step before deciding. There's no right answer for every homeowner.