What is a Home Equity Investment?

With housing prices increasing significantly nationwide, many people are tapping into their home’s equity to complete home renovation projects or consolidate high-interest debt. Typically, this is done with a cash-out refinance, home equity loan, or home equity line of credit.

Unfortunately, these methods can be costly and have rather strict lending requirements.

If you have less than ideal credit, you might not know where to turn to access the cash you need. That’s where Home Equity Investments (HEI) come into play. 

While an HEI is a great way to access your home equity if you have a lower credit score, it does come with some risk and strings attached. 

Keep reading as we explore home equity investments, their structure, and some pros and cons you should consider before getting started.

What is a Home Equity Investment?

A home equity investment is a way to convert the equity in your home into cash. This is done by selling a portion of your home’s future value to an investment company. In exchange, they will give you a lump sum of cash representing a piece of your current equity.

Even though an investor purchases a piece of your home’s equity, they do not gain ownership, and their name is not added to the title. Instead, they are only given the right to profit from your home’s future appreciation.

Home equity investments are similar to a home equity loan or home equity line of credit because they give you access to your home’s equity. However, the biggest difference that attracts most people to home equity investments is that you won’t make a monthly payment or need to deal with interest rates. 

How Do Home Equity Investments Work?

Home equity investments are pretty straightforward. You and the investor will agree on a cash amount and the equity share you will give up to access the cash. 

For example, you might ask for a $45,000 lump sum payment and, in exchange, will offer 15% of the future appreciation on your home.

Let’s take a look at how the process will work.

1. The Investor Will Have Your Home Appraised

The very first thing a potential investor will do before entering into a home equity investment is to have the home appraised. Don’t be shocked if the appraised value is below what you expected. Often, investors will lower the appraised value slightly to protect their investment if housing prices decline.

However, you should also be aware that most investors will also limit the amount they can earn if home prices appreciate substantially.

2. An Offer Is Made

Once the appraisal has been completed, the investor will give you an offer. This includes the lump sum payment you qualify for, the share of equity they request, and the repayment terms.

Typically, investors will ask for the repayment to be completed anywhere from 10 to 30 years. However, even if it’s set for 30 years, you can usually repay the investment earlier.

3. You’ll Sign an Agreement, Pay Closing Costs, and Receive Your Payment

Once you’ve agreed to the terms of the deal, you’ll sign a contract and pay closing costs. This will include the appraisal cost, an origination fee, and other third-party fees.

Once this is done, you’ll receive the agreed-upon lump-sum cash payment.

4. Repayment

At the end of the repayment term or an earlier date if you choose, you’ll make a payment that includes the original loan amount and the share of equity you owe.

Home Equity Investment Example

Below, we’ll walk through an example to better understand how a home equity investment works and the cost.

Let’s assume your home has an appraised value of $400,000 and you have $150,000 in equity. The investor decides they will offer you $80,000 of your equity in exchange for a 20% share of the home’s future appreciation.

Now, let’s assume the value of your home increases to $600,000 in the next ten years, and you decide to pay back the investor and exit the deal. In this situation, you would make a payment that includes the original $80,000 investment plus 20% of the appreciation over the past ten years, which would look like this.

$80,000 + 20% ($600,000 – $400,000) = $120,000

Pros and Cons of Home Equity Investments

Before choosing to move forward with a home equity investment, it’s important to understand the pros and cons.

Pros 

• No monthly payments: Unlike a home equity loan or home equity line of credit, you won’t make a monthly payment. Instead, you’ll make one lump-sum payment when you repay the loan. This can help keep money free in your monthly budget.
• Less strict requirements: Because you’re not making monthly payments, your credit score isn’t as much of a focus. Most investors will require anything above a 500 credit score.
• You can use the funds any way you’d like: The investor in your equity typically doesn’t care how the funds are used. This allows you to use them to pay off high-interest debt, complete home improvements, take a vacation, pay for a wedding, or anything else.
• Potentially long repayment terms: Most home equity investments have repayment terms of between 10 and 30 years. That means you could potentially pay $0 on your loan for up to 30 years.

Cons

• You’re sharing your future appreciation: In exchange for access to your home equity, you’ll give up some of the home’s future appreciation. This could be a significant amount of money depending on how much home prices increase.
• The overall cost is unknown: When you take out a home equity loan, you know exactly how much you’ll pay each month in interest based on your interest rate. However, with a home equity investment, it’s hard to know the total cost because you don’t know your future home value.
• Not available in all states: Home equity investments are a newer way to access the equity in your home. Because of that, they won’t be available to homeowners in each state. 

Who Should Consider Using a Home Equity Investment?

Home equity investments are a great option if you’re looking to gain access to the equity in your home. You might want to consider using a home equity investment if you prefer to keep your total debt at a minimum and not make an additional payment each month.

Home equity investments will also be ideal for homeowners with significant equity that they want to access but don’t have the best credit score.

Alternatives to Home Equity Investments

Before deciding to use a home equity investment to take out equity in your home, consider a few alternatives.

Home Equity Loan

Home equity loans are another way to access the equity in your home. However, unlike a home equity investment, these are second mortgages.

That means in exchange for a lump-sum cash payment, you’ll have a repayment schedule with a monthly payment. Your monthly payment will be determined based on the loan amount and interest rate.

Home Equity Line of Credit

A home equity line of credit (HELOC) will give you access to a line of credit based on your home equity. This is very similar to how a credit card works.

Most HELOCs will have a draw period (typically ten years), where you can take draws whenever you need the cash. 

Cash-out Refinance

With a cash-out refinance, you will replace your current mortgage with a mortgage that has a higher balance. The difference is then given to you as a lump-sum cash payment.

The Bottom Line

If you have less than perfect credit or want to avoid additional monthly debt payments, then a home equity investment could be a perfect way to access the equity in your home.