You’re a big proponent of reverse mortgages. You saw how one gave your parents the extra cash they needed to stay in and fix up their home, pay off bills, and have enough money to travel and see you and the grandkids whenever they wanted. Of course, they were still required to stay current with property taxes and homeowners insurance, the home maintenance and otherwise meet their loan obligations.
After their passing, you sold their home to pay off their reverse mortgage, and after the balance was paid, the remainder of the home’s sale proceeds went to you. Although your parents’ loan balance had risen over the years, their home had also appreciated, helping offset what was owed on the reverse mortgage. Taking out that reverse mortgage was a win for your parents and for you.
So now you’re ready to duplicate their success. There’s just one problem. You’re not 62, the minimum age requirement for a reverse mortgage. You have a few years to go. And there’s another issue. You need money now. You’ve got plenty of home equity. You just need an alternative financial tool to help convert some of your home equity into cash.
Here are three ideas, two of which are probably familiar, and one that’s a little outside the box.
A cash-out refinance replaces your current home loan with a new mortgage that’s higher than your outstanding loan balance. You withdraw the difference between the old mortgage balance and the new balance in cash. A cash-out refinance can be an ideal solution when you’re able to replace your current mortgage interest rate with a new lower interest rate.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a second mortgage that is tacked on to your current mortgage. Instead of your funds getting disbursed to you in a lump sum, as happens with a cash-out refinance, you have access to a credit line that you can draw on as needed for a set period up to your approved limit.
Shared Equity Agreement
A shared equity agreement, also known as a shared appreciation agreement, is a financial agreement that allows another party to invest in your property and acquire a stake in its future equity. In exchange for receiving a lump sum of money, you promise the investor a portion of your future appreciation. You won’t have to make any monthly payments on the amount, nor pay any interest on the money you’re advanced. Note that if you enter into a shared equity agreement, and then find that you don’t qualify for refinancing or a reverse mortgage upon the maturity date, you could be forced to sell your home at that time. This is a far less traditional financial remedy than either a cash-out refi or a HELOC, but one you should at least be aware of.
Upon a closer look, the shared equity agreement is neither a loan nor a mortgage, but a contract binding you to repay the investor after a set number of years or upon the sale of your home. How much you must repay the investor will largely depend on your home’s increase or decrease in value.
Let’s say you have a home worth $500,000 with a $200,000 mortgage, giving you $300,000 in home equity. You would like to tap $50,000 of that equity to remodel your kitchen and bathroom. An investor agrees to give you the $50,000 in exchange for a 30% stake in any appreciation you realize after 10 years.
After 10 years, your home is now worth $600,000, giving you $100,000 in appreciation of which the investor will take 30% or $30,000. When the contract becomes due, you would pay the investor the original amount you received ($50,000), plus the 30% return on their investment ($30,000), for a total of $80,000.
Of course, as with all investments, what goes up can also go down. If after 10 years, the home was worth only $400,000 (recession, pandemic, home is near a Superfund cleanup site, etc.), you would repay the investor only $20,000. You owe only that amount because the investor’s 30% stake in your home resulted in a loss of $30,000, which you subtract from the original amount of money you initially received ($50,000 – $30,000 loss = $20,000 repayment). As these two examples illustrate, the investor shares in both your gains and losses.
Know What You’re Getting Into
If you want to explore the shared equity arrangement further, be prepared to ask a potential investor lots of questions:
What are the triggers for repayment? Typically, investors require repayment if you sell your home or the contract term expires. Find a term that works best for you.
What percentage stake is the investor taking in your future appreciation (or depreciation)? If one proposes 25% and another 35%, that will be a key differentiator. But don’t let price be the only deciding factor in your decision.
What are the total expenses to do the deal? We already mentioned potential servicing, appraisal, and escrow fees, but there could be other fees like title, transfer, recording fees, and so on, so get a full accounting of potential expenses. Then use a calculator to compare the costs of a shared equity agreement with other financing options. Given the current low-interest rate environment, it may make more sense for you to obtain a home equity loan or line of credit than losing a portion of your future appreciation.
How long will it take to get your money? The answer you get may determine which investor you select.
What’s the investor’s reputation? This is critical. You want the company to deliver on whatever it promises.
Suit Your Circumstances
As noted, with a shared equity agreement, you won’t have to make any monthly payments, and you won’t pay any interest on the amount of cash you receive. Meanwhile, if your home appreciates, you will likely earn enough to cover the initial investment while also seeing your home equity rise. It will be a plus for you and your investor. If your home depreciates, you still got your money but won’t have to pay it all back because the investor shared in your loss.
If you are considering a shared equity agreement, consider the timing as well. Say, you’re 52 now, you could structure your shared equity agreement for 10 years, pay off the investor at the end of the term, and then take out a reverse mortgage, as you would now be 62, the minimum age requirement for a reverse mortgage. If you’re 57, you could structure a 5-year shared equity agreement, then apply for a reverse mortgage.
Bottom line, as a homeowner who has likely built up equity over the years, you have many options to convert some of that equity into cash. Be prepared to weigh several important factors as part of your decision-making process, such as where you think housing prices and interest rates are headed, along with your needs and goals for the money, your current age, and your investment philosophy.
We hope this article has given you some help with things to think about. Of course, every situation is different. This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.
Q. Could the shared equity investor, as a co-owner or partial owner, move in?
A. In a shared equity arrangement, the investor does not move in.
Q. Where do I find shared equity investors?
A. Top-selling real estate agents in your area will likely have a list of investors to share with you. Also enter “shared equity agreement companies” in your favorite search engine to identify companies that specialize in this area.
Q. Do I have to make payments, including interest, on the amount of money I receive from a shared equity investor?
A. No. You are only responsible for repayment if you sell the home or reach the maximum time limit, specified in your agreement.