Broker Check


July 06, 2017

Turning home equity into cash through a home equity line of credit or a new mortgage is a common transaction. With the house as collateral, the interest rate and monthly payments will be lower than most unsecured loans, and under current tax law, the interest may be deductible. Some loans may permit a period of interest-only payments, which further reduces the monthly obligation.

But what if it were possible to access home equity without adding a monthly loan payment? That’s the attraction of several investment companies that offer cash to homeowners in exchange for an equity position in their house. Quoting a website blurb: “(W)e make it easy for homeowners to sell small fractions of the equity in their home to investors.”

This unique transaction, just recently available to consumers, is a new take on monetizing home equity. While the suitability of this strategy depends on individual circumstances, the underlying concepts are straightforward. Instead of assessing a borrower’s ability to repay a loan, the investing institution is relying on the property’s anticipated appreciation to yield a profitable return.

Here’s an overview of a hypothetical transaction:

Consider a home with a market value of $500,000, and an outstanding mortgage balance of $300,000. The homeowner’s equity position is $200,000 or 40% of its market value.

A home-equity investment firm offers $50,000 to the homeowner in exchange for a 10% equity position in the house.

Based on an analysis of the property, the agreement may call for the investor’s ownership to increase incrementally over time. Assume this calls for the investor to be a 12% owner by the end of the agreement. Within 10 years, the homeowner must buy out the investor, at a price based on the home’s value at that time. This can be accomplished through three different procedures:

  • The property can be sold, with some of the net proceeds used to pay the investor.
  • The property can be re-assessed, and the homeowner can use other funds to buy back the home equity.
  • The property can be re-financed (as either a new mortgage or home equity line of credit) to complete the buy-out.

Suppose the home’s value increases to $600,000 over 10 years. The investor, now holder of a 12% stake in the property, is due $72,000 from the homeowner. But if the market value declines, the investor might receive less than the original $50,000 buy-in.

Like other equity transactions, investors are hoping for share appreciation. The $22,000 gain on a $50,000 investment might seem substantial, but over 10 years, the annualized return is less than 4 percent.

There are additional risks for the investing company. If a homeowner defaults on the mortgage, it could result in a foreclosure to the lender, and the possible liquidation of the property at a discount, leaving investors with a loss or, in a worst-case scenario, nothing at all.

To mitigate against this possibility, the investment company typically takes an equity position of no more than 10 percent, and strives to ensure that the homeowner retains at least a 20 percent equity interest. If there’s a foreclosure, these parameters make it more likely there will be enough excess equity to fully repay the investors. 

Better? No, Just Different

Compared to a home equity loan, a fractional sale of home equity might seem attractive because it requires no payments, and the eligibility requirements, in terms of equity percentages and creditworthiness, are less stringent. But the adage “There is no free lunch” applies to this transaction.

  • Like a home equity loan or new mortgage, a fractional equity sale incurs fees and closing costs, which are typically subtracted from the cash received by the homeowner.
  • Further, the investment companies say the true cost to the homeowner is estimated at between 7% and 11% annually (compared to a 5% average annual interest rate for current home equity loans). But actual costs will not be known until the investors are bought out.

In the example above, an investor seeking a 7% annual rate of return over 10 years would have to receive close to $100,000 from an initial $50,000 investment. To hit this target, the $500,000 home in the example must either have a market value of closer to $1 million after 10 years, and/or the investor’s ownership stake must incrementally increase to more than 12 percent.

  • Homeowners with a lot of equity may not be able to access as much when compared to a home equity loan. A $1 million-dollar house owned free and clear might be able to secure a home equity loan for 70% of value, far more funds than a 10% equity sale would provide.

That said, there are circumstances where a partial sale of home equity could be a good fit. An April 23, 2017, Wall Street Journal article offers the example of a California couple with a property valued at $1.7 million, of which they held $1 million in equity. The homeowners received $170,000 in exchange for a 10 percent share of their property, using the money to eliminate debts, make renovations, and lower their monthly obligations.

As a “clean-up” prior to retirement this transaction could fit, especially if the homeowner plans to downsize. The cash flow benefits are immediate, and the requirement to buy out the investor is covered by the anticipated sale of the property.

Converting home equity to cash may be a financially savvy move, but whether it’s a loan or fractional sale, transactional costs should be factored into the decision. Homeowners don’t have to consult with anyone beyond a lender or potential investor before accessing home equity, but a conversation with one of your financial professionals before pulling the trigger might be prudent. 

This newsletter is prepared by an independent third party for distribution by your Representative(s). Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice. Links to other sites are for your convenience in locating related information and services. The Representative(s) does not maintain these other sites and has no control over the organizations that maintain the sites or the information, products or services these organizations provide. The Representative(s) expressly disclaims any responsibility for the content, the accuracy of the information or the quality of products or services provided by the organizations that maintain these sites. The Representative(s) does not recommend or endorse these organizations or their products or services in any way. We have not reviewed or approved the above referenced publications nor recommend or endorse them in any way.      

Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. PAS is an indirect, wholly-owned subsidiary of Guardian. Lifetime Financial Growth is not an affiliate or subsidiary of PAS or Guardian. © Copyright 2017   2017-41381   Exp. 6/2019