How does home equity sharing work?

Home equity has long been a tool available to homeowners looking to borrow money at an affordable rate, leaving more money left over to craft a happier life. Typically, that means taking on new debt, but that’s not your only option.  

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Home equity sharing is an alternative way to tap into your home equity, offering many benefits that traditional financing doesn’t, such as not having to make any monthly payments. There are other things to take into consideration, however, such as planning for a large balloon payment many years in the future.

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We’ll help you understand how the different home equity sharing options work and what to consider in this article.

What is home equity sharing?

In order to help you understand what home equity sharing is, first let’s compare it to its ubiquitous cousin: debt-based home equity financing such as mortgages, home equity loans, and home equity lines of credit (HELOCs).

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Debt-based financing allows you to borrow money and repay it over time with monthly payments through a process called amortization, meaning that a portion of your monthly payment goes towards debt, and another portion toward interest. In order to ensure repayment, the lender will file a lien against your home, allowing them to foreclose on it if you default on the loan.

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Home equity sharing companies also allow you to take out money, and they, too, will file a lien against your home in order to secure their repayment. However, rather than paying back an outstanding debt balance over time with steady monthly payments, you’ll repay the funding with one single balloon payment at the end of the term period or when you sell your home, whichever happens first.

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Rather than paying a known amount of interest to your lender, your repayment amount will be calculated as a percentage of the equity in your home at the time you pay back the money. This is a key difference — repayment is due in full at the end of the contract, and is calculated as a share of the equity in your home.

Home equity sharing process

The actual process of taking out a home equity sharing agreement doesn’t look much different than taking out a debt-based financing product.

Taking out a home equity sharing agreement

First, you’ll need to submit a prequalification application. You’ll generally need to include information such as your name, Social Security Number, home address, and mortgage details. You may also need to provide copies of certain documents, such as recent tax returns, pay stubs, and bank statements.

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The home equity sharing company will review your file and decide whether you’re a good candidate for a home equity agreement. Prequalified homeowners will receive an estimated offer, detailing your potential funding amounts and payback terms. Be aware that most companies will add a “risk adjustment” to the value of your home, which protects them against losses in value, so your actual home value and your home value for funding purposes may be different.

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If you agree to the terms, the home equity sharing company will proceed with closing, which involves ordering an official appraisal of your home. You’ll receive the final closing documents to sign in the presence of a notary. It’s important to read these documents carefully and note if anything has changed from the prequalified offer.

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Once you sign and submit the documents, the company you’re partnering with will take out any closing cost fees and disburse the remaining cash to you.

During the home equity agreement term

You’ll need to agree to certain conditions as a part of your contract. Generally, this includes keeping up with regular maintenance and property taxes on your home, at a minimum.

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Depending on the company you’re working with, you may have other restrictions as well, such as not being able to rent out your home during the contract term or notifying the home equity sharing company of any plans you have to sell your home. These restrictions are good things to note in advance.

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This is also a good time to plan how you’ll repay the investment later, especially if you’re not planning on selling your home anytime soon. Most home equity sharing agreements last 10 to 30 years, which is plenty of time to build up your credit score and income to qualify for a loan to repay your home equity agreement, for example.

Repaying your home equity agreement

When the term period is at an end, you’ll need to repay the funds you borrowed. If you sell your home, the equity sharing company will generally use the sales price as the final value. If you’re using cash savings, taking out a loan, or using some other way to repay the funds, the company may order another appraisal at this point to determine the fair market value.

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The equity sharing company may apply some last adjustments to your home’s value, such as if you remodeled your home or didn’t keep up with maintenance. Once your final home value is calculated, the company will compare it with your initial home value in order to determine your repayment amount. You’ll then need to send the funds in, and the lien will be released from your home.

What are the different types of home equity sharing agreements?

Most home equity sharing agreements work the same way. However, when it comes to repaying the funding, equity sharing companies differ in whether they calculate your repayment amount as a portion of your total home value, or only the amount of appreciation your home has experienced over time.

Total home value

Some companies calculate your repayment as a simple percentage of your home’s total value (with any value adjustments factored in).

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For example, let’s say your home is worth $800,000, and you receive $80,000 to fund a new home addition in exchange for 20% of your home’s total value in 10 years. If your home is worth $1,000,000 by then, you’ll need to repay $200,000 total ($1,000,000 x 0.20). In this case, you borrowed $80,000 and paid $120,000 in equivalent financing costs.

Appreciated value

Rather than basing your repayment on the total value of your home, some companies limit it to just a fraction of the appreciated value — i.e., the amount of equity that has grown over time. Your repayment amount may be calculated as a straight percentage of this amount, or — as Point does — your repayment amount may be calculated as the original amount you borrowed, plus this percentage of future appreciation.

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Our example home from above appreciated in value by $200,000 ($1,000,000 - $800,000). If your home equity sharing company requires a 25% share of your future appreciation — plus the original amount you borrowed — you’d need to repay a total of $130,000 ($80,000 + [$200,000 x 0.25]). In this case, you’d have borrowed $80,000 and paid $50,000 in equivalent financing charges.

Who’s eligible for a home equity sharing agreement?

When you apply for a home equity sharing agreement, your application will be evaluated on two things: your own personal financial situation, and your home’s properties.

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Here’s what companies are looking for in terms of homeowners:

• Income: Varies, but typically less than for debt-based financing. Some companies, such as Point, will not consider your income at all.
• Credit score: 500 or higher
• Loan-to-value ratio: Up to 80%
• Debt-to-income ratio: Varies; may be required to use some funds to pay down your debt.

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Most home equity sharing companies only offer funding to owner-occupied residential homes. Often, mobile homes, investment properties, and second homes aren’t eligible.

What can you use your funds for?

Another beauty of home equity investments is that you have flexible use of your funds. You can generally use them for anything you want, even for multiple things at once. Here are some common uses:

• Debt consolidation
• Higher education costs
• Second home purchase
• Investment opportunities
• Home improvements, upgrades, and repairs

What are the pros and cons of home equity sharing?

Pros

• No monthly payments
• Funds can be used for almost anything
• Credit and income requirements easier to meet
• Early contract buyout allowed with most companies

Cons

• Balloon repayment
• Lien placed on home
• Foreclosure potential if you default
• Exact financing cost unknown until end of contract
• Value adjustments can complicate repayment calculation

Final thoughts

Debt-based financing such as home equity loans and HELOCs are useful for homeowners looking to maintain a high degree of control over the equity in their home, but they shrink your monthly cash flow and typically come with significant credit and income barriers.

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Homeowners who aren’t able to qualify for these options, or who want a more flexible way to repay the money they borrow, may be able to use a home equity sharing agreement to help them afford a better life for themselves and their families.

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If you’re curious to see how much you could get with a home equity sharing product, you can check your eligibility here.