How to Tap Your Home Equity Without The Loan Payments
It is a simple fact of real estate investing that cash is needed to get deals done. Yet, cash always seems to be in short supply. For many individual investors, one of the most logical places to find it is in the equity of their primary residence.
Traditionally, the way to access home equity is through a loan or line of credit. While these products may serve as a means to an end, they increase leverage on the primary home, require monthly debt service, and can have variable rates of interest, exposing borrowers to additional interest rate risk. Recently, several new companies have introduced a product that seeks to maintain the benefits of an equity loan while mitigating the weaknesses, it is called “home equity co-investment.”
What is Home Equity Co-Investment?
The concept behind home equity co-investment is simple. Rather than work with a lender to take out a line of credit, a homeowner enters into a contract with an investor to sell a percentage of their home’s equity in return for an upfront payment. While the contract is in place, no interest is due and there are no periodic monthly payments. Instead, the investment must be repaid when a “qualifying event” occurs such as a mortgage refinance or home sale. To secure their position, the investor will place a lien on the home that is typically subordinate to the primary mortgage.
To illustrate how this works, assume that an individual investor owns a home worth $250,000 and has a primary mortgage of $150,000 on it. By definition, they have $100,000 in equity. In addition, assume that the same investor needs $50,000 to fund their share of a multifamily investment. Rather than take out a HELOC, the investor could sell $50,000 of their home’s equity to an investor and use the upfront payment to fund their multifamily investment. In doing so, they would give up their right to 50% of their home equity by essentially taking on a partner in their home. Upon a qualifying event, such as a refinance or sale of the home, the homeowner is required to repay the investor for their share of the equity. Assuming home prices have gone up, the investor would make a profit.
Pros and Cons of Home Equity
The primary benefit of this arrangement should be immediately clear. Once the equity is sold, there are no monthly payments and no interest is charged on the upfront payment. The homeowner is free to do whatever they want with the upfront payment including paying off debt, funding renovations, or investing in a real estate deal.
The ancillary benefits are also powerful: home equity co-investment deals can close as quickly as 10 days, the approval criteria tend to be more favorable than a traditional HELOC, and the home equity investor will participate in the downside of their investment – to a limit- in the event that the home’s value falls.
Conversely, a home equity co-investment can turn out to be an expensive proposition if the home’s value rises significantly because the investor participates in the downside and the upside. If the same $250,000 house goes up in value to $350,000 while the mortgage goes down to $90,000, the investor’s 50% share of the equity is now worth $130,000. In addition, the homeowner may have less flexibility if they are unable to make the payment on their primary mortgage and may have less say in whether or not to accept an offer when the home is for sale. In short, the homeowner has taken on a partner and has to agree with them on all major decisions for the duration of the investment contract.
At present, home equity co-investment is a relatively niche product that may only be a good choice in specific situations. But, home prices have grown significantly over the past 10 years and there is a significant amount of “tappable equity” in the United States. In their October, 2019 Mortgage Monitor Report, Black Knight Financial estimates that there is $6.2 Trillion in tappable equity as of the end of Q32019, which indicates that the market for home equity co-investment could be significant.
To be clear, we are not endorsing home equity co-investment as a method for generating cash. We are simply presenting it as a new and interesting alternative to the traditional HELOC. The lack of monthly payments and interest positions it as a product that real estate investors may find useful. However, the additional restrictions placed on home ownership and the potential for giving up a portion of the gains may make it untenable for some.
For anyone interested in learning more about the product, we recommend performing an internet search for the leading providers and strongly recommend that the legal documentation be read very carefully and that all aspects of the deal be considered before committing to it.