Are home equity investments a good way to get cash out of your home?

Imagine tapping your home’s value for cash without having to take out a loan. The money’s tax-free, and you don’t pay interest on it — in fact, you don’t make monthly payments at all. You don’t need a high credit score or income to be eligible and can get prequalified in minutes.

That’s the pitch of home equity investments (HEIs), also known as shared equity agreements or shared equity investments. Get funds now, repay us later, after your home appreciates, the companies offering them say. Win-win, as one firm puts it.

But don’t be misled. HEIs are not the same as other, more familiar home equity products, like home equity loans or lines of credit (HELOCs). With an HEI, you get a lump sum of cash in exchange for a percentage of the future value of your home. While that sounds straightforward enough, it often isn’t.

“My concern is that consumers are not understanding what they are getting into,” says David Friend, an attorney who previously worked for the CFPB and the Department of Housing and Urban Development. “Even as a lawyer, I had to read it [the HEI contract] five or six times to figure out, ‘What is going on here? How is the money flowing? What happens, when?’”

In fact, the Consumer Financial Protection Bureau (CFPB) in January issued a consumer advisory spotlighting the risks associated with HEIs. The shared equity agreement “sounds like a great deal: the company will pay you money now, as an ‘investment’ in your home, and you pay them back later with a share of how much the house increases in value,” the advisory stated. “What the company may not tell you is that, even if your home loses value, you will probably still have to pay the company more than you received.”

What are some of the CFPB’s concerns? What do consumers need to be aware of before entering into these agreements? How can they protect themselves from risks? Let’s invest some time exploring home equity investments.

What is a home equity investment?

Pitched as an alternative to cash-out refinances, home equity loans and HELOCs or reverse mortgages, HEIs are a relatively new product. Unison is generally credited as the first HEI provider, launching in 2006, followed in the mid-2010s by Point, Hometap and Unlock. Others include Aspire, Splitero and CHEIFS. They do not operate in every state, but the industry is growing, with its volume estimated at between $2 billion and $3 billion.

HEIs offer an upfront payment, giving a homeowner “the opportunity to access their home equity without having to take out a loan,” says Michael Micheletti, chief marketing officer of Unlock Technologies, based in Tempe, Arizona. The lump sum carries no monthly repayments or interest charges, because the HEI company technically is not loaning money but making an investment in your residence — similar to the way a venture capitalist funds a fledgling business.

Homeowners “are essentially selling us a portion of their equity today that they built up, in exchange for us sharing in that home value in the future,” Micheletti says. The HEI company gets a return on its investment — repaid, that is — when you sell your home or the contract’s stated period ends. HEI contracts typically run 10 to 30 years.

The type of borrower who might consider an HEI is one who doesn’t qualify for traditional home equity financing, like home equity loans or HELOCs. Eligibility requirements vary depending on the company, but they are usually less stringent: no income or debt-to-income criteria, and a minimum credit score of only 500. That’s one of their big benefits. You typically need at least 20 to 30 percent equity in your home to access a maximum of 80 to 85 percent of your home’s value for up to $500,000, though some companies may have higher investment limits.

“No monthly payments equals no income requirements, which should in theory then provide the consumer with a ton of flexibility to get back on their feet to do whatever they need to do to get their financial house in order,” Micheletti says.

Risks of home equity investments

While an HEI could be the right product for some homeowners, several factors could make it a less-than-ideal option for others.

1. Contract terms can be complicated

At the heart of the HEI agreement is that you are giving up a share of your home’s future value in exchange for a lump sum. However, there’s no standard industry practice on how HEI companies calculate that lump sum or how much your home is worth.

One company may determine your payout either by looking at the total value of the home or how much the value has changed. Another may take the appraised value of the home, then discount it, to come up with a risk-adjusted “starting property value.” Unison, for example, applies a 5 percent adjustment to the starting value of your home after getting an appraisal. These discounted values will play a role in calculating how much your property has appreciated come payback time.

The formula for figuring the company’s return can be complex too. For example, Aspire determines its payment at the end of the agreement by taking a percentage of your home’s appraised value and multiplying it by what it calls an “investor multiple.” This means Aspire’s share will increase as the years continue, though it’s limited to a 12 percent annual return in the first three years of the contract.

One of the big selling points of an HEI is no monthly payments — but that doesn’t mean it’s cost-free. You may also have to pay origination fees, servicing fees and settlement charges, which can add up to thousands of dollars. For example, Hometap charges a 3.5 percent fee for arranging and funding the investment. In addition, third-party charges, like the appraisal and title fees, will be deducted from the final amount of money you receive.

Of course, home equity loans and HELOCs often come with such charges too. Typically, home equity loan closing costs add up to 2 to 5 percent of the loan amount. For a $100,000 loan, that equates to $2,000 to $5,000, which can be rolled into the loan principal or paid out-of-pocket. For fixed-rate loans and mortgages, such costs – along with your monthly payments – have to be delineated to consumers on standardized loan estimate forms.

HEI companies also provide advance estimates, but the fact that they operate so differently can make it hard to compare their terms and the total cost of their investments.

2. You could pay back more than expected

When it’s time to settle up, you could owe far more than you anticipated if your home appreciates more than expected. Or even if it doesn’t appreciate.

Each HEI company works in a slightly different way. Here are two potential scenarios, based on the way one firm (Aspire) does its calculations.

Let’s say the value of your home is $500,000 — the company’s risk-adjusted starting property value, which is the appraised value, minus 15 percent. Let’s say you want a lump sum of $75,000. If home values increase by 3.5 percent each year, and you exit the agreement in 10 years, your future home value will be $705,299. While your share would be $441,097, you will owe more than $264,202 to the HEI company. That’s $189,202 more than the original investment.

Even if your home loses value, you may still have to pay the company more than you received. In the same home value and investment amount as above, if your annual home value decreases one percent each year of the 10-year agreement, its future home’s value would be $452,191. While your share will be $358,837 at the end of the agreement, you will owe the HEI company $93,354. That’s more than $18,000 of the original payout.

How can this be? Basically, because of the way the HEI firms calculate things – not just your home’s value, but their return on their investment. To quote the CPFB, “Home equity contracts are typically not structured to provide a cash payment to homeowners equal to the value of the consumer’s home equity pledged. Instead, home equity contract companies require a multiple of their initial payment… For example, a homeowner may get paid 10 percent of the value of their home in exchange for a 20 percent stake in their home’s future value. This 2x multiplier means that the company would double their money before factoring in any home price appreciation.”

In fact, that’s almost exactly how Unlock operates. You may receive a payment worth 10 percent of your home, but when you sell or the agreement ends, the company collects 20 percent of its value – whether the property is worth more, worth less or stays the same. To its credit, Unlock is quite transparent about this, explaining the terms in an easy-to-read equation in its Product Guide. The point is, it’s getting back a bigger share than it put in.

Traditional home equity lenders receive considerably more than the sum that they give you, too, thanks to a little something called interest. Take our hypothetical $100,000 home equity loan above. Assuming a 10-year term and a fixed 8 percent rate, you’d pay over $45,500 in interest, bringing the total cost of your loan to $145,593. But this amount is amortized in monthly payments. Also, a lender has to disclose this total upfront; no waiting to see what your home’s worth or what you’ll pay out at the term’s end.

Some HEIs do offer rate caps that limit how fast the repayment amount can grow. Still, there’s no way to know exactly what you will be obligated to pay at the end of the agreement, because there’s no way to be sure what your home will appraise for. Given the math of its multipliers, though, a home would have to decline radically in value — by at least half, the CPFB’s report estimates — for the HEI firm to lose money.

3. You may have to take on debt after all

At the end of the contract term, you must pay back the HEI provider. As we’ve seen above, the amount due can be huge. Often, “there’s realistically little way to make the payment at the end,” Pizor says.

In order to satisfy the agreement, you will either have to sell your home, or — if you want to keep on living there — dip into savings or seek financing from a lender. The latter is the most usual course.

“Typically, [the homeowner] will go get a mortgage product, because now they can qualify for that and get back on that much more sustainable debt path,” says Micheletti at Unlock. “They could do a cash-out refi, they could do a home equity loan, they could do a home equity line of credit to exit the agreement and buy back the equity as per the terms of the agreement.”

You can always repay the entire amount you owe before the contract ends, of course. “From what we’ve heard, most people don’t keep [HEIs] for the full term, which means the payments are not going to be quite as bad, because it hasn’t been going on as long,” says Pizor. “But they’re still going to be very, very expensive.”

Depending on the contract, length of your agreement and the appreciation or depreciation of your home, that could add up to tens of thousands of dollars. And some companies charge early exit fees, too. Homeowners who can’t afford the full settlement cost might have to put their place on the market or face foreclosure.

“A lot of people in 10 years are going to be like, ‘I had no idea it was this bad.’ Then what are they going to do?” asks Wendy Gilch, founder of Selling Later, a consumer advocacy platform that provides educational resources and professionals for home buyers and sellers. “They’re going to have to sell their home or take out a loan to pay off the thing that wasn’t a loan.”

4. You may face restrictions

With an HEI, the company has a financial stake in your home and that can come with certain conditions.

You will retain ownership of the property and be responsible for paying the mortgage, property taxes and insurance, but depending on the company, it may put a lien on your house. It may even demand to be legally recorded on the title as a co-owner of the property, though that’s rare.

It might not be a completely silent partner, either. You typically need approval from the HEI company before renting out, selling the home or refinancing your existing mortgage. Additionally, you might also be charged a fee for that refinance.

Some companies have restrictions on early repayment unless you’re paying the full amount. Others have specific timeframes for when they give you credit for renovating your home and won’t share in any losses if you sell the home before a certain time period. While most companies don’t have restrictions on what you can use funds for, in some cases, you may be required to pay off debt or pay off property liens with the cash you receive at closing.

Also, HEIs “follow the title,” not the borrower. That means if you die with the agreement still in force, anyone who inherits the home inherits the agreement too. Though not personally liable, they will have to settle the lien somehow: by paying it in full or selling the home, which could put them in a tough position.

“If a homeowner stays in the house long enough, they can leave their equity to the next generation,” says Pizor. “Some people, depending on the house, can maybe get a traditional refinance loan and pay off the amount that way, but then you’re handing your children debt, which is a problem.”

5. You may lack consumer protections

HEI providers say their products are not loans, but investments. Although some authorities dispute that claim (see below), it currently means that, as investors, they are not bound by the same rules as traditional lenders. Legislation like the Truth in Lending Act and the Dodd-Frank Act, designed to protect consumers from predatory practices, don’t apply. In short, you won’t get the same standard mortgage disclosures and other protections that typically come with a traditional home loan.

For example, “the Dodd-Frank Act said you cannot put a forced arbitration clause into a mortgage, which means consumers have the right to go to court if there’s a dispute over the terms of the mortgage,” says Pizor. “But these [HEI] agreements have arbitration clauses. So if you want to go to court, dispute it, break the contract and say ‘I was deceived,’ you get forced into arbitration most of the time.”

A HEI firm gets its payout all at once, at the end of the agreement or when you sell the home. The CFPB has noted that this lump-sum repayment is reminiscent of the risky features common to mortgages in the years before the 2008 housing crisis.

“They’re a lot like subprime mortgages. They have a big balloon payment at the end,” says Pizor. “Imagine you’re going to get a mortgage and someone says, ‘There’s only one payment at the end. I can’t tell you what the payment is and what the interest rate is until you get to the end.’ That’s kind of what these are like.”

Courts and regulators have yet to agree on how to handle HEIs. Given that the Trump administration has ordered the CFPB to stop nearly all of its work, federal enforcement of any applicable laws is somewhat in limbo. However, some states, like Maryland and Connecticut, have adopted laws classifying HEIs as mortgage loans. As of early March, Washington state is in the middle of a legislative session that is likely to pass a new bill governing HEI contracts, which includes mandatory disclosures about fees and how the investment company values homes.

What to do before signing up for an HEI

Understanding what you are getting into with an HEI is extremely important. In a review of nearly 40 complaints, the CFPB says consumers reported being frustrated or misled about HEI contract terms and costs, including how homes are valued.

Before signing up, make sure you read the fine print, as each HEI company has different terms, calculations and restrictions. HEIs take a percentage of your home’s future value, so it’s important to crunch the numbers to see how much it may cost you in the long run. Part of that cost may be a forced sale if you can’t pay what you owe when the agreement ends. To make sense of it all, it wouldn’t hurt to enlist the help of a housing counselor or real estate attorney.

“You need to think about, ‘How long are you going to be in the house? Is this company going to be around? Will you be able to satisfy the terms of the obligation?’ It’s something that consumers have to be extremely careful about if they’re entering into” an HEI, Friend says.

Home equity investments: the pros and cons

As the value of home equity continues to grow, consumers will be looking for ways to tap into their homeownership stakes, including with HEIs. “It’s an expanding market,” says Heather Cantua, deputy managing partner at Scale, a law firm based in Washington. “Of course, I do agree that there’s going to be some bad products out there, but there are good-use cases for this. Eventually, as it gets bigger, consumers will have a deep understanding of these, similar to how they had to develop that knowledge for a 30-year mortgage.”

A share in your home’s appreciation sounds simple enough in exchange for no monthly payments, no interest, and quick access to cash. If you don’t fit the traditional borrower profile, due to a low credit score, shaky credit history, irregular income or other unconventional finances – if you are “house rich, cash poor” – an HEI could well be the best way to access your equity.

But bear in mind: In between the share percentage multipliers and the discounted starting values, the deal’s frequently structured so that the HEI company will make money, even if you lose money (like if you had to sell your home for less). Depending on the company and the change in your home’s value, you could be on the hook for two to four times the percentage the company invested.

Even if your home appreciates significantly, you may end up paying more in the long run than you would for a traditional home equity product. You could also run into difficulties refinancing or create complications for those inheriting the property.

The bottom line: HEIs are run by professional investors looking for a return on their money. So you have to watch out for your interests too. It may not seem like a traditional loan or debt, but you are undertaking an obligation. Before you sign a home equity investment contract, “make sure you understand every single thing about it,” says Friend.