What is shared equity?
Shared equity is a broadcast category of strategies for extracting the value locked up in a person’s equity in their home. There are many different ways that this is done, but they all have one primary thing in common: they give money to the homeowner for a share of the future appreciation or value of the home when it is sold.
Some of these strategies go by the name of shared equity investment, home equity investments (HEI), home equity agreement (HEA), equity sharing agreement (ESA), shared appreciation mortgage (SAM), and shared appreciation program. Many of these concepts have slight variations or are only called different things by companies. In every one of these cases the primary tactic is to trade money now for a share in the equity of real estate property at the time of its sale.
What is a shared equity loan?
A shared equity loan is a financial instrument where a company will give a homeowner money in exchange for a percentage of either the sale of the home or the appreciation in the home when it is sold. Some companies don’t call it a “loan” but use words like “agreement” or “investment,” because in many ways the arrangement doesn’t look anything like what we would normally call a loan. These agreements do not have monthly payments, a traditional APR (or interest rate), and no fixed term.
What is the APR on a shared equity loan?
It would be impossible to predict what the APR of a shared equity loan (or a shared equity investment, or shared equity agreement) would be until the completion of the arrangement. In many ways, it is not appropriate to call it a loan at all. That would be like saying that buying a stock is a way of “lending” someone money in exchange for partial ownership in a company. You would not know what owning that share in the company was worth until you sold it. You could sell it in three years, five years, or thirty years.
Annual percentage rates (APR) can only be calculated when you know the length of a loan, the amount borrowed, and the cost of borrowing. In the case of shared equity loans, the only known value is the amount borrowed. And “borrowed” isn’t the right word for it, either. A homeowner is selling a share of their future equity in their home for a predetermined amount.
What is a shared equity agreement?
A shared equity agreement is when a homeowner sells a stake in the equity of their home for an investment. The homeowner gets the money immediately and the investor must wait for the homeowner to buy out the agreement or sell the home to share in the equity of the house. The agreement always specifies that the payback will include the initial principal and a percentage of either the total sale of the home or the appreciation of the home since they entered into the agreement.
How does a shared equity agreement work?
Shared equity agreements can be very confusing. We want to think of them like a mortgage or home equity line of credit, where money now is traded for monthly payments of principal and interest. But that’s not how shared equity works. Shared equity is more like selling shares in a company in exchange for whatever value that company holds in the future. When we think of it more like investment it starts to make a little bit more sense.
A homeowner sells a portion of their future equity of their home to a shared equity company. That company gives them a lump sum of money that the homeowner can do whatever they want with it. When the homeowner repurchases the agreement or when the home is sold the shared equity company receives the lump sum amount that they gave the homeowner plus a percentage of the sale of the home.
[Consider building a infographic flow chart to explain.]
Shared equity companies have different ways of calculating what share they get at the time a home is sold. Some shared equity companies take a percentage of the total sale regardless of how much the home is sold for. Other shared equity companies take only a percentage of the appreciated value of the home which means that if the home actually depreciated they would lose money.
There are other variations within these basic principles. For instance, a shared equity company may have a cap on how much it will take if the home appreciates dramatically or a company might be able to make adjustments to the value of the home if they feel the homeowner did not adequately take care of the property. All of this would be delineated in the shared equity agreement at the beginning.
Some of the general principles around shared equity include the following:
Shared equity agreements do not have monthly payments because the shared equity company earns its money when the home is sold.
Applications for share equity agreements almost never have traditional underwriting. While they may check your credit, they are more concerned about whether your home currently has enough equity to qualify.
Home equity requirement
In order to obtain a shared agreement, a home must meet the company’s standard for the amount of equity in the home. This could be anywhere between 25 and 50%. Having 25% equity in your home means that mortgages on the home don’t exceed 75% of the home’s current appraised value.
Example of evaluating a home’s equity: A home was appraised for $300,000, but the current balance on the home’s mortgage is for $180,000. That means that they have $120,000 in equity ($300,000 value minus $180,000 that is owed on the home), which means that the home has 40% equity ($120,000 ÷ $300,000 = 40%).
The homeowner decides at the beginning of the shared equity agreement how much of the equity they want to pull out of their home. Each company has a different range of approved amounts. For instance, one company will only let you take out between 5-17.5% of the equity. Others will allow you to pull up to 50% out.
Term, or length of the contract
Unlike a traditional loan where it is clear when the loan is paid off, shared equity agreements have no natural limit. They extend until a change in the home’s ownership. This change can be a sale or the homeowner buying out the contract. This can happen in a couple of years or in twenty years. This uncertainty can make it very difficult for a homeowner to know how to evaluate whether they want to engage in a shared equity agreement.
Share of the home’s future value
Since there are no monthly payments in a shared equity agreement, the company get their money back and makes a profit when the home is sold. The shared equity agreement stipulates what percentage of the future sale the company will get. This percentage is often based on the amount of equity taken out of the home as well as the appreciation of the home. There are two broad ways in which companies determine how much of the home’s future value they get: total sale value and appreciation.
Total sale value
The shared equity agreement that calculated their payout based on the total value of the sale of the home often offers higher equity pay-outs early in the loan. Total sale value agreements are like selling a percentage of your home to the company.
Other shared equity companies will assess their share of a home sale only on the appreciated value of the home. These companies typically offer lower equity amounts.
Appreciation example: At the time of the shared equity agreement, the home was appraised at $200,000. Five years later, the homeowner sold the home for $250,000. The appreciation was $50,000.
The cash-out amount is the amount of equity a homeowner can pull out of their home at the time of the shared equity agreement. The amount permitted will depend on the company’s policies and the current equity in the home.
Shared equity companies currently do not operate in every state.
Unison currently offers shared equity agreements in the following states: Arizona, California, Colorado, Delaware, Florida, Illinois, Indiana, Kansas, Kentucky, Massachusetts, Michigan, Minnesota, Missouri, Nevada, New Jersey, New Mexico, New York, North Carolina, Ohio, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Utah, Virginia, Washington, Wisconsin, and Washington, D.C.
Point currently offers shared equity agreements in the following states: Arizona, California, Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Nevada, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, Virginia, Washington, and Washington, D.C.
Unlock currently offers shared equity agreements in the following states: Arizona, California, Colorado, Florida, Michigan, Minnesota, North Carolina, New Jersey, Nevada, Oregon, South Carolina, Tennessee, Utah, Virginia, and Washington.
Type of dwellings eligible
Hometap currently offers shared equity agreements in the followings states: Massachusetts, Michigan, Minnesota, Nevada, Ohio, South Carolina, and Utah.
How long does it take to get a shared equity loan?
The process normally only takes a couple of weeks to secure a shared equity agreement. Some of the things that could cause delays could be home appraisals or tracking down any other paperwork.
What are some examples of how shared equity agreements work?
Shared equity agreements don’t look like traditional mortgages or personal loans, so they can be a little confusing about how they work. Sometimes the best way to understand them is to see an example.
Shared equity agreement Example
A homeowner has a home that has been appraised for $307,000 and currently owes $183,000 (which means they have 40% equity in the home). The homeowner would like to take $31,000 in equity with the shared equity agreement. The homeowner sells the home for $356,000 five years later after the home has appreciated an average of 3% per year.
|Original home value||$307,000|
|Equity in the home||$124,000|
|Shared equity cash-out||$31,000|
|Sale price (5 years later)||$356,000|
|Company take||$85,000 ($31,000 original cash-out + $54,000 equity share)|
|Homeowner’s share of the sale||$270,000|
You can’t technically calculate an APR on a product like this because the time and the return are both uncertain. If the appreciation is less than 3% or the homeowner sells the house during a recession, could all have dramatic impact on the nature of return. However, if you were to calculate the cost of the loan after the fact, it would say that the $31,000 cost somewhere in the neighborhood of 35% per year over the course of the five years.
For a mortgage, that seems like an expensive form of credit. For someone with poor credit, that would be a good personal loan. For someone who simply can’t absorb another monthly payment and needs to solve a financial problem, it could be what they need.
Home equity Agreement (HEA) example
A homeowner has a home that has been appraised for $503,000 and currently owes $278,000 (which means they have 45% equity in the home). The homeowner would like to take $46,000 in equity with the shared equity agreement. The homeowner sells the home for $583,000 five years later after the home has appreciated an average of 3% per year. This company has slightly different terms and end up earning $128,000 from the sale.
|Original home value||$503,000|
|Equity in the home||$225,000|
|Shared equity cash-out||$46,000|
|Sale price (5 years later)||$583,000|
|Company take||$123,000 ($46,000 original cash-out + $77,000 equity share)|
|Homeowner’s share of the sale||$454,000|
The company made back their $46,000 and an additional $77,000 on top of that. Of course, in this circumstance, the homeowner took the $46,000 and paid off $40,000 of credit card debt. For five years, they were saving 18% interest on the debt that they would have paid for. Furthermore, they took the money they would have made to those payments and increased their 401k contribution.
What the homeowner did with the money helped to ease the impact of losing that future equity. That made the situation dramatically different than if they had used that money to increase their spending.
Shared Appreciation Agreement example
In this example, the company only shares in the appreciation of the home. After six years, the homeowner sells their home, but because the market was depressed, they sold for a price that was only slightly above the appraised value of the home when they entered the shared appreciation agreement. The
|Original home value||$503,000|
|Shared equity cash-out||$88,000|
|Sale price (5 years later)||$519,000|
|Company take||$109,000 ($88,000 original cash-out + $21,000 equity share)|
|Homeowner’s share of the sale||$410,000|
The homeowner ended up getting $410,000 from selling the house that was appraised at $503,000 just five years earlier. We must, of course, consider the $88,000 they received at the time of the agreement. This means that the homeowner ended up with $498,000 of value ($410,000 from the sale + $88,000 cash from the equity sharing agreement).
Is shared equity agreements a good idea?
Shared equity agreements (also known as shared equity loans or shared equity investment) don’t function like traditional loans. It can be difficult to know what the money is really going to “cost” over time. This is because these arrangements often rely on predicting the future. How long you keep the agreement, how much your home will appreciate (or depreciate), and when you might want to move have a significant impact on what a shared equity agreement will ultimately cost you.
Of course, this uncertainty doesn’t mean that they are bad financial options. It just means that it will require a little more understanding to make a decision on whether it is the best option for you at the time.
Shared equity may be the best way for a homeowner with fair or poor credit to get the money they need to take the next step in their financial journey. On the other hand, entering a shared equity agreement (especially if the terms are not favorable) could jeopardize your ability to build wealth over time.
The following are some scenarios when entering a shared equity agreement could be a good idea:
- When your present financial crisis could cause you to lose your home
- When a significant infusion of money now could dramatically change the trajectory of your financial progress
- When you aren’t relying on the equity in your home for retirement
- When the money from a shared equity agreement provides opportunities for wealth creation
The following are some scenarios when entering a shared equity agreement could be a bad idea:
- When you expect the value of your home to play a significant role in your retirement
- When the money gained from the shared equity agreement is for consumption
- When the agreement from the company would force you to give up a disproportionate amount of the value of your home when you sell it
- When the money you get from a shared equity agreement won’t actually fundamentally change your situation
What is the difference between a shared equity loan and a home equity line of credit (HELOC)?
A home equity line of credit and a share equity agreement are only similar in that they are financial instruments that rely on the equity and value in your home. A home equity line of credit (HELOC) is a traditional loan that has an interest rate, a monthly payment, and is secured by the value of the house. Because it is a line of credit, it doesn’t have a fixed loan length and money can be drawn and paid back repeatedly. As an open line of credit, the interest rate usually floats with the FED fund rate. A shared equity loan is not really alone but is an opportunity for a homeowner to sell the future Equity of their home for money today. The investment does not have an interest rate or monthly payments and the investor receives their money only at the time of the sale of the house or when the homeowner buys them out of the contract.
Another difference between a home equity line of credit and a shared equity agreement is that a HELOC will require a comprehensive underwriting process to ensure that you will be able to afford the monthly payment. Because the shared equity agreement has no monthly payments, the primary requirement is that the home has some equity in it. Homeowners with damaged credit can qualify for a shared equity agreement.
|Home equity line of credit (HELOC)||Shared equity agreement|
|APR||Variable, but consistent||N/A|
What is the difference between shared equity and a reverse mortgage?
A reverse mortgage, also often known as a home equity conversion mortgage (HECM), is a financial instrument only available to homeowners over the age of 62. In a reverse mortgage, a homeowner borrows money based on the equity of their home, but instead of repaying the loan with monthly payments, the loan is repaid when the homeowner sells the home. A shared equity loan is similar in that the loan is repaid when the home is sold of the borrower repays the loan
|Reverse mortgage||Shared equity agreement|
|Loan amount||40-60% of appraised value of the home||Less than 50% of appraised value of the home|
|Loan distribution||Lump sum, monthly payout, or line of credit||Lump sum|
|APR||Standard mortgage rates||N/A|
|Monthly loan payments||None||None|
|Underwriting||Age, home equity threshold, ability to maintain the home||Loose|
|Related names||Home equity conversion mortgage (HECM)||Shared equity investment, home equity investments (HEI), home equity agreement (HEA), equity sharing agreement (ESA), and shared appreciation mortgage (SAM)|
What is the difference between a shared equity loan and a shared appreciation mortgage (SAM)?
A shared equity loan or a shared equity agreement is an arrangement between a homeowner and an investor. The investor gives the homeowner a lump sum of money in exchange for a percentage of the proceeds when the home is sold. A shared appreciation mortgage is similar in that the lender shares in the future increase in the value of the home, but it is a traditional mortgage. The lender trades off a better interest rate or a lower down payment in exchange for participation in the future sale of the home.
|Shared appreciation mortgage (SAM)||Shared equity agreement|
|Loan amount||Standard mortgage||Less than 50% of appraised value of the home|
|Loan distribution||Home financing||Lump sum|
|Monthly payments||Standard mortgage||None|
|Share in equity at sale||Yes||Yes|
What is the difference between shared equity and sell & lease back programs?
A shared equity arrangement is when a homeowner sells a percentage of a homes equity in exchange for a lump sum of money today. A cell and leaseback program is when an investor buys the home from the homeowner and leases or rents back the property to the homeowner. In these Arrangements the homeowner has the option to buy back the home or instruct the investor to sell the home in which case the homeowner often shares in the appreciation of the property.
|Sell and lease back||Shared equity agreement|
|Homeowner retains ownership of the home||No||Yes|
|Homeowner benefits from appreciation on sale||Yes||Yes|
|Loan||Lump sum||Lump sum|
|Monthly payments||Rent or lease payments||None|
What do people use shared equity loans for?
For most American homeowners, the equity in their home is the largest asset and it represents their financial prosperity. So, why would anyone sell part of that equity? Well, there are several reasons why people use shared equity agreements or loans. Some of them include:
- Pay off high-cost debt: Debt can drag down a person’s financial progress and sometimes clearing that debt can be the fastest way to begin to build financial stability and wealth. Shared equity agreements may be one of the few options available to people to obtain a meaningful amount of money with which to pay off debts.
- Clear medical debt: Medical costs have a way of ballooning quickly. And when there is a medical emergency, you have few options to shop around or decide to delay spending. A shared equity agreement can provide the resources needed to clear medical debt and allow you to breathe a little easier.
- Pay for remodeling: A person’s home is their most valuable asset. It is also central to their lives and day-to-day well-being. Delaying needed home repairs can often cause them to be more expensive as the situation deteriorates. Upgrading your living space can also do a lot to improve your day-to-day happiness. But, finding the money for home improvement projects can be a challenge, especially if you have damaged credit. Shared equity agreements may allow you to accomplish the home improvements you might have thought were out of your financial reach.
- Make a big purchase: It’s hard to save up for big purchases and might feel frustrating to know you have built up significant equity in your home, but that it is unreachable. Shared equity agreements allow people to release some of that value even if they have less-than-ideal credit.
- Business startup funding: Betting on yourself and starting a business can be one of the most empowering things a person can do in their lives. But, starting a business takes money, even for modest personal businesses. Getting that money can often be the budding entrepreneur’s biggest challenge. Share equity agreements can be a method for people to get small business funding when banks reject their applications.
- Pay for education: Education has become increasingly expensive. Financial aid can often be elusive for middle-class American families and student loans can be a significant anchor on a young person’s effort to launch into adulthood. Shared equity agreements can be a way in which families can use the equity that they’ve built up in their home to empower the next generation’s education.
What are the pros or the advantages of a shared equity agreement?
Shared equity agreements (or shared equity loans) can be a little confusing. They aren’t mortgages and they aren’t loans. It might be hard to see through the confusion and understand what the advantages might be to using a shared equity agreement.
Some of the pros are:
- Protect your monthly cash flow: Because shared equity does not require monthly payments, you can use your current cash flow for the things that are important to you today.
- Don’t need to afford another monthly bill: Shared equity agreements give you access to a lump sum amount but does not come with a monthly loan payment. So, if your monthly budget is already tight and couldn’t absorb another payment, shared equity could be a way out of a financial emergency.
- Easy to obtain approval: Companies that offer shared equity agreements are mostly concerned with whether there is equity built up in your house. Since they don’t require monthly payments, they don’t need to do the same level of affordability checks and underwriting. Homeowners with credit scores in the low 500s can usually get a shared equity agreement.
- Damaged credit doesn’t mean a worse deal: In most other kinds of lending, the worse your credit score the worse the APR you can get approved for. This is not true of shared equity agreements because the company is mostly interested in the equity built up in your home, not your day-to-day finances.
- High debt-to-income (DTI) ratios don’t matter: Getting money through shared equity agreements aren’t technically debt and don’t have monthly payments, so traditional debt-to-income ratios don’t matter.
- No interest is charged: Interest expense can be one of those things that can silently siphon money out of your life. Shared equity agreements have no interest expense
- Won’t hurt your credit score: Because shared equity agreements are not loans, they will not show up on your credit report. They will not impact your utilization rate. They can’t show late payments (because they have no payments). And they can’t pull down your credit score.
- Money can be used for anything: There are no restrictions on what can be done with the proceeds from a shared equity agreement.
What are some of the cons or disadvantages of a shared equity agreement?
Share equity agreements can be confusing. Without monthly payments, how can I know if they are hurting me? Without an APR, how can I know how much they cost? Are they better or worse than other credit options? What are the disadvantages to entering a shared equity agreement that I should be aware of?
Here are some of the cons of shared equity agreements:
- Uncertainty: You should definitely read a shared equity company’s terms and conditions, but some of the factors that will affect whether it was ultimately a good idea can’t be known: how much appreciation will my house gain? When will I sell the house? Will I need my home’s equity in the future?
- Costs you in future wealth: Traditional loans impact your monthly finances, so you can sense how much they are costing you. Shared equity agreements cost you in the future value of your home. In short, shared equity agreements cost you some of your future wealth. That cost is harder to “feel.”
- Require a large portion of your appreciation: Shared equity companies have different terms, but some of them will charge a meaningful portion of the appreciation in your home. Some will even charge you based on the total value of your home, so you are losing a lot of value even if the home doesn’t appreciate.
- Hidden costs: Keep an eye on additional costs like appraisal fees, origination fees, and other closing costs. Not all companies charge them, but when they do, they might feel especially hidden since these aren’t traditional loans.
- Equity requirement: While shared equity agreements don’t have strict underwriting requirements, they do require that you have at least 25% equity in your home.
- Expensive in places with high appreciation: If you live in an area where homes have appreciated quickly and consistently, a shared equity agreement may cost you a lot more than it otherwise would. This is because these companies share in the future value of your home.
- Fine print: Some contracts allow the shared equity company to manually adjust the value of your home up when you sell it if they think you haven’t adequately taken care of the property. That can feel like an arbitrary power that allows them to take more of the equity. You need to look very closely at the fine print to avoid running into future problems.
- Does nothing to help your credit score: Because shared equity agreements are not loans and do not show up on a credit report, they will do nothing to improve your credit score.
What are some home equity sharing companies? What companies offer shared equity loans?
Even amongst companies that offer home equity sharing options, there are dramatic differences in their policies, terms, and experience. You should always do your research to determine which company is best for you. The following are just a few of the companies that offer shared equity agreements:
- Easy Knock