What Is a Home Equity Agreement?

The equity in your home is one of your most valuable financial resources. But what if you aren’t ready to sell your home, or your credit isn’t strong enough to qualify for traditional financing? Fortunately, you may still be eligible for a home equity agreement (HEA).

Home equity agreements are a relatively new financing option that can help you access the equity in your home by borrowing against your home’s future equity. And, while similar to home equity loans, there are some key differences, such as no monthly payments.

Learn how home equity agreements work, their advantages and disadvantages, and whether one is right for you.

In this article (Skip to...)

• What is a home equity agreement?
• How does a home equity agreement work?
• Pros and cons of home equity agreements
• Example of a home equity agreement
• Home equity agreement alternatives
• The bottom line

What is a home equity agreement?

A home equity agreement, also referred to as a shared equity or home equity sharing agreement, is a financial arrangement that allows homeowners to access a portion of their home’s equity without incurring additional debt.

Unlike traditional home equity loans (HELs) or home equity lines of credit (HELOCs), which involve making payments and incurring interest charges, a home equity agreement provides homeowners with a one-time lump sum from a lender or investor.

How does a home equity agreement work?

Like traditional home loans, the terms of a home equity agreement are largely influenced by the home’s current value and appraisal, making it an appealing choice for those with substantial home equity.

A home equity agreement functions differently from traditional mortgage options, however. Here’s an overview of how an HEA typically works:

1. Appraisal and Agreement: The process starts with an initial appraisal to determine your home’s current market value. Using the appraised value, your lender or investor offers a lump sum in return for a portion of your home’s future appreciation. The percentage of equity exchanged depends on the lump sum amount and the specific terms of the agreement.
2. Lump Sum: Once the HEA is finalized, you’ll receive a lump sum payment. These funds can be used for various purposes such as home improvements, debt consolidation, or investments. Unlike traditional loans, no monthly payments are required, providing additional cash flow flexibility.
3. No Monthly Payments: A key benefit of home equity agreements is that they don’t involve monthly payments. This can be especially advantageous if you have lower credit scores and may find it difficult to meet the repayment terms of traditional loans.
4. Settlement of Agreement: The agreement is usually settled when it comes time to sell the property, refinance, or after a specified period. At that point, the lender or investor receives their agreed-upon share of the home’s appreciation (or depreciation). It’s important for homeowners to be aware of any origination fees and other costs associated with settling the agreement.

Pros and cons of home equity agreements

While home equity agreements may not be for everyone, they can offer several benefits to some homeowners. Be sure to gain a proper understanding of the advantages and disadvantages that come with an HEA.

Pros

Many home equity sharing companies have lower credit requirements than home equity loan lenders. This means it’s typically easier to qualify even with less-than-perfect credit. Income requirements tend to be less stringent, as well.

Different from traditional borrowing methods like home equity loans or a cash-out refinance, home equity agreements don’t involve monthly payments or interest charges. This can be a significant benefit for those with limited cash flow or who want to avoid taking on additional debt.

Another unique benefit to home equity agreements is that when you and an investor co-own the property, the risk is shared. The investor has a vested interest in coming to an agreement that’s mutually beneficial for all parties.

Co-owning your home with an investor means you’ll have more financial wiggle room to pay off debts, save money, or make necessary repairs to your home.

Cons

HEAs may not be suitable for risk-averse homeowners looking to safeguard their assets.

A home equity sharing agreement can be compared to a balloon-payment loan, where the looming deadline can create significant financial pressure.

If your financial challenges are long-term and unlikely to improve, the same issues making it difficult to cover monthly payments now could also make it difficult to repay the full amount at the end of the agreement—potentially forcing you to sell your home.

At the end of the term, you must repay the entire investment along with a percentage of your home’s appreciation. If you pass away, your heirs will need to settle the agreement by either selling the property or paying the company’s share, which is no small consideration.

It’s also important to understand the impact of market fluctuations when it comes to home equity agreements.

If your home’s value appreciates significantly and you choose to sell, an equity sharing agreement may reduce the overall profit from the sale. On the other hand, if your home’s value drops substantially, repaying the initial funds received from the home equity sharing company could become more challenging, though you may only need to repay a portion depending on the terms of the agreement.

An example of a home equity-sharing agreement

Prior to entering a home equity agreement, it’s important to get a full breakdown of what one looks like.

For instance, many agreements require you to repay the initial amount plus a percentage of your equity equal to four times the percentage invested. Here’s an example of how home equity-sharing may look based on this type of agreement:

Let’s assume your home appraised for $400,000. The home equity agreement shows the lender will offer you a lump sum of $40,000 in exchange for four times your home’s future appreciation.

If you sell the house for $400,000, the HEA company would be entitled to $40,000 (its original investment). You can use the $40,000 you received as you see fit, but there may be penalties if you fail to repay it when the house is sold.

Now, if the home’s value rises to $500,000, in addition to the initial $40,000, the investor would receive 10% plus 40% of the $100,000 increase—an extra $40,000 for a grand total of $80,000. If the equity agreement is repaid before any appreciation occurs, no additional payment is typically required.

How to find the best home equity agreement companies

Home equity sharing companies are becoming more popular and widespread. Some of the more well-established ones include Hometap, Unison, Unlock, and Point.

Since a home equity sharing agreement could become expensive down the line, it’s vital to carefully compare the reputation, repayment terms, and the percentage of your home’s appreciation or value each company will claim.

Additionally, consider the upfront costs, as many companies charge origination and appraisal fees, which can add to the overall expense.

Another important consideration is to evaluate how lenders calculate the risk-adjusted value of your home, as this can impact the terms of the agreement. Taking the time to thoroughly assess these factors will help you choose a company that offers favorable terms and minimizes long-term costs.

Home equity agreement alternatives

Home equity agreements are just one option for gaining access to your home’s equity without having to sell your home. Be sure to compare all available options and understand the costs and risks involved. Other options include:

Cash-out refinance

A cash-out refinance enables you to refinance your current mortgage for a higher amount, with the extra funds provided as cash. This option can be beneficial for consolidating debt or covering significant expenses. However, it typically extends your repayment term and may involve higher interest rates or origination fees. It also requires a strong credit score and sufficient equity in your home.

Home equity loans (HELs)

Traditional home equity loans offer a lump sum with fixed interest rates and consistent monthly payments, making it a viable option for homeowners who value stability in their repayment plan. However, it adds to your overall debt and requires monthly payments. A strong credit score is necessary for favorable terms.

Home equity line of credit (HELOC)

HELOCs provide a flexible revolving credit line that allows you to borrow cash as needed, often with lower interest rates compared to personal loans. Monthly payments fluctuate based on the amount borrowed. Bear in mind that your interest rate may increase, resulting in higher payments over time.

Reverse mortgage

Designed for homeowners aged 62 and older, reverse mortgages let you tap into your home’s equity without the burden of monthly payments, making it a useful way to strengthen your retirement income. However, it reduces the inheritance value of the home, as interest accumulates over time, gradually diminishing the remaining equity available to heirs.

The bottom line on home equity agreements

Whether you’re looking to finance a remodel, consolidate debt or make a large purchase, a home equity agreement could be a great way to unlock your home’s value without incurring new debt or monthly payments. It’s crucial to balance the immediate financial benefits with the potential downsides, however, such as forfeiting a portion of future appreciation and the obligation to settle the agreement.

Be sure to thoroughly evaluate your financial needs and long-term plans when considering a home equity agreement. Seek advice from a lender or financial advisor to explore alternatives like refinancing, home equity loans, or HELOCs.

By carefully weighing the pros and cons of each option, you can make informed decisions that best support your financial goals.