Buzz
Although owning your own home isn't the simple solution for building wealth that it's sometimes made out to be, it's still a reliable way to increase your net worth over time. Beyond the personal satisfaction of owning property, your home is often the biggest asset you will ever have.
As you gradually pay off your mortgage, you increase your ownership in the home—the percentage of the property you own outright. This is great news for most people, especially since the value of homes typically rises over time, despite occasional market fluctuations. For instance, home values surged by over 40% between 2009 and 2020. This is crucial, especially considering that a large portion of Americans struggle with savings—over a third couldn't manage $400 in an emergency, and many have less than $5,000 saved. Accessing home equity can provide a vital financial cushion.
However, unlocking that equity can be tricky. Usually, you'd tap into it through a home equity line of credit (HELOC), a home equity loan, or by refinancing the mortgage for a lump sum cash-out. But if you have poor credit or don't have enough liquid cash to cover closing costs and monthly payments, you could be locked out of accessing your property's value. Fortunately, there's another possibility: A home equity investment (HEI).
What is a Home Equity Investment (HEI)?
A home equity investment is an agreement where an investor loans you a portion of your home's equity in return for a share of its future value. There are two main types of these arrangements:
Equity sharing, where the investor acquires a minority ownership stake in your property, and their share increases as the home’s value appreciates.
Shared appreciation, where the investor buys a percentage of your home’s future increase in value.
In both cases, there is a set loan term, typically ranging from 10 to 30 years. When the term expires, you must repay the original loan amount plus a share of the property's appreciated value. For instance, if your home is valued at $250,000 with $100,000 in equity, and an investor lends you $50,000 in exchange for 25% of the future appreciation over a 10-year term, after 10 years your home is worth $370,000. The property has appreciated by $120,000, so you owe the investor $80,000—$50,000 plus one-fourth of the $120,000 appreciation.
In an equity sharing arrangement, you would receive the $50,000 loan, and the investor would take a 25% share in the property. If you sell your home for $370,000 after 10 years, depending on the terms of your agreement, the investor could receive $92,500—one-quarter of the increase in the home’s value. Naturally, if your home appreciates less—or even depreciates—the amount you owe the investor could be considerably lower.
Home Equity Investments (HEIs) can vary significantly depending on the lender, so the figures provided here are just for illustration. If you’re considering this option, make sure to carefully examine any agreement to fully understand the terms, as these loans come with both major benefits and potential drawbacks.
The benefits and drawbacks of a home equity investment
Here are a few reasons why an HEI might be a good choice for you:
You’re low on cash. While HELOCs and refinancing are often better ways to access home equity, they come with loan costs and monthly payments. If you’re not sure you can handle monthly payments, HEIs can be a better alternative since they don't require them. However, many HEIs do come with origination fees that you'll need to pay.
You have poor credit. If your credit score is too low to qualify for traditional home equity loan options, an HEI may be your only choice to access the equity in your home. Since HEIs are based on the value of your property rather than your creditworthiness, your credit score won’t play as significant a role.
You want to avoid adding more debt. HEIs are considered investments, not debt. If you’re trying to avoid taking on more debt, an HEI can help you tap into your home’s value without increasing your debt load.
However, there are a few potential downsides to keep in mind:
They’re balloon loans. HEI agreements allow you to receive funds without regular repayments, but the full amount is due at the end of the term. For example, after 10 years, you’d owe the lender $80,000, all of which must be paid in a single lump sum. If you haven’t planned ahead, you may find yourself needing to sell your home, even if it’s not something you want to do.
They can be more expensive. If your home appreciates significantly, you could end up paying more to access your equity than you would with a traditional home equity loan. On the flip side, if your home’s value drops, you might owe less than the original loan amount.
Your mortgage lender might prohibit it. Some mortgage agreements explicitly forbid selling off portions of your home equity, so trying to arrange an HEI might lead to legal issues. Be sure to check your mortgage agreement and consult a lawyer before moving forward.
Over time, your home becomes a significant part of your wealth, but it’s essentially tied up in a form that’s hard to convert into cash. If you’re unable to access your equity, a home equity investment could be a helpful solution—just make sure you fully understand what you're getting into before proceeding.
