Shared Appreciation: Tapping Home Equity Without Taking a Loan

By Hal M. Bundrick, CFP

Shared appreciation agreements let you access home equity in exchange for a share of your property's future appreciation. For creditworthy borrowers, home equity loans or HELOCs are a better choice.

By giving an investor a slice of ownership in your property, you can tap your homes equity without taking out a loan or even double your down payment on a new house. Its called a shared appreciation agreement: Youre actually allowing a silent partner to take a stake in your home.

What is a shared appreciation agreement, and who is it for?

A shared appreciation sometimes called shared equity agreement allows you to cash out some of the equity in your home in exchange for giving an investment company a minor ownership stake in the property. While the investor cannot live in the home or lease it out, it participates in the increase or decrease in the value of the property.

The transaction is secured like a loan but doesnt require a monthly loan payment. At the conclusion of the agreement term, you pay back the company the equity advance it gave you, as well as a percentage of the appreciation in your property value.

Shared appreciation mortgages have been around awhile; todays shared appreciation programs are a new spin on an old pitch. Offered by companies such as Patch Homes, Point and Unison, they arent technically mortgages because you dont make a monthly payment.

These products primarily target homeowners who are home-equity-rich but cash-poor with credit challenges.

Perhaps most importantly, theyre a product that primarily targets home-equity-rich but cash-poor homeowners facing credit challenges.

How a shared equity agreement works

• You want to tap the equity in your home
• If you qualify, a shared appreciation company gives you that money
• In return, you give it a stake a percentage of the future appreciation of your home
• You make no monthly payments to the company
• The company has no occupancy rights, but there is a lien against your property, just as with a typical loan
• You pay back the equity value the company gave you, plus its share of the homes appreciation at the end of the term of the agreement often 10 years. (Typically, you also have the option to pay back earlier.)

For all practical purposes, a shared equity agreement is a lot like a balloon-payment loan. The 10-year term looms large. Youre facing a deadline to pay back the entire investment, and quite likely, a percentage of your homes appreciation. That is no small consideration. For that reason, these agreements are not for the risk-averse or the faint of heart.

What happens at the end of the agreement?

Complication is the enemy of clarity. And these shared appreciation agreements are definitely complicated.

First off, youll pay for an appraisal of the home. But that value will be discounted by the investor for risk purposes. And not just a little bit typically from 10% to 20% of the value will be lopped off. As an example, a 15% risk adjustment on a $750,000 home would make the property worth $637,500 for calculating the future appreciation of the home.

The companies that manufacture these agreements show examples using round numbers of a homes future value or loss. But the fact that they discounted your homes value from the very beginning of the agreement can mean you start off owing more than you received from day one, no matter how your propertys value changes.

If the home appreciates, you pay back the companys investment in your home the equity you receive plus its stake in the increased value:

• Before the agreements 10-year term ends, perhaps by qualifying for a cash-out refinance with another lender
• Or when you sell the home prior to the end of the agreements 10-year term
• Or when you reach the end of the agreements 10-year term. At that point, youll have to sell, refinance or find the money.

Each shared equity investor calculates the outcomes a bit differently.

If the home doesnt gain in value, youll pay back the equity you drew, and you may also pay back the risk-adjusted discount that the investor took.

If the home loses value, at least a portion of that loss in value will be deducted from the equity you drew. Be aware that depreciation may be calculated from the original appraised value of the house, not the risk-adjusted discount.

The investors take a greater share of ownership than the equity they give. You might get 10% of your home equity in exchange for giving away a 25% share of ownership.

And then theres the fact that the investors take a greater share of ownership than the equity they give. You might get the use of 10% of the equity in your home for giving away a 25% share of ownership.

Who might benefit from a shared appreciation agreement?

For most homeowners, this is an alternative to a HELOC or home equity loan, Point co-founder Eoin Matthews says. We are able to underwrite to more forgiving standards, which means homeowners that might have substantial equity in their home, but dont qualify for a HELOC or home equity loan can qualify for a shared appreciation agreement, he says.

Sahil Gupta, co-founder of Patch Homes, says a sizable number of its customers are small-business owners and contract employees.

Lending standards from traditional lenders are extremely strict and very cumbersome, especially for small-business owners and 1099 contractors, Gupta says.

You have consumers, especially homeowners today, who are asset-rich but cash-strapped, he adds. In places like the Bay Area, in Los Angeles, in New York and major metros, you have consumers living in million-dollar homes, but theyre making $75,000 to $80,000 a year in income.

Gupta says that after paying their mortgage, student loans, a car loan, credit cards and family expenses, some homeowners dont have enough savings to face unexpected major expenses.

And thats when shared equity programs might be a solution.

Who can qualify?

While Point doesnt have an absolute cutoff on credit score, Matthews says that it might be very challenging to underwrite borrowers with FICO scores below 550.

These are not homeowners building huge pools and tennis courts, he adds. These are homeowners who have worked really hard to get their finances in good shape and oftentimes have gone through very tough times. We focus on homeowners who are going to use this for improving their finances.

Patch Homes Gupta says his firms customers are also typically suffering cash flow and liquidity problems.

These are homeowners who have a credit score on the low end the majority fall between 640 and 720, Gupta says.

Typically, customers have their home about half paid for, prior to drawing equity.

All things considered, well-qualified borrowers are best-served by traditional home equity loans and HELOCs.

How much does it cost?

Unison takes a 2.5% origination fee; Patch Homes and Point both take a 3% processing fee from the equity draw.

These companies typically take a 15% to 25% share of appreciation.

Important considerations of shared equity offers

• This is not a HELOC-sized equity withdrawal. You may get somewhere between 10% and 20% of your homes equity. Some homeowners want bigger checks than we can write, Matthews says. We get some homeowners who want HELOC-sized [checks] maybe $300,000 or $500,000 particularly in the coastal areas.
• There are fees. Say you are looking to draw $50,000 cash. The check you get will be less a 3% fee ($1,500) and title, escrow and appraisal fees (well estimate that to be $1,000). Youll get a check for about $47,500.
• Luxury properties may not qualify. Point shies away from luxury properties, as well as homes on large acreage, because of the value volatility for such homes. Its unusual for us to do anything thats over an acre in size, Matthews says.
• The same goes for smaller homes. Properties worth less than $300,000 are not the easiest in the world to do, Matthews adds.
• Big cities are favored. These companies prefer to serve areas with large, growing populations.

Patch Homes is currently available only in California, with expansion to Washington state planned by the end of the year.

Point is available in five states: California, Colorado, Massachusetts, Oregon and Washington. Imminent are Georgia, Virginia and Washington, D.C., with a half-dozen states expected to be added next year.

Unison has the largest geographic coverage, with service in Arizona, California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, New York, Oregon, Pennsylvania, Virginia, Washington and the District of Columbia.

Its not for everyone

All things considered, well-qualified borrowers are best-served by traditional home equity loans and HELOCs .

If you have a 780 credit score and you have amazing income, then a bank solution makes perfect sense for you because you can get a HELOC at prime plus 3% or prime plus 4% , Gupta says.

For anyone who has liquidity problems, I think equity sharing makes sense. If they dont have liquidity problems, then they should not be doing this product, he adds.

Hal is a personal finance writer at NerdWallet. He is a certified financial planner and former financial advisor.