Imagine being able to tap into the equity of your home without any payments or interest.
It sounds too good to be true, right?
In today's financial marketplace, there are options for just about everything, and a growing new form of financing called home equity investments or home equity contracts does just that.
With these contracts, a company provides the homeowner a payout that is paid back in 10 or 30 years or if the home is sold. There are no payments before then. You aren't charged interest. Instead, you are required to pay an amount dependent on the appreciation or depreciation of the value of your house.
Much like anything in the financial realm, there are pluses and minuses to HEIs, but as estate planners, we're reluctant to see our clients commit significant sums of money that will need to be paid right when retirement starts or years after.
The attorneys at The Orlando Law Group can help look at all options of a home equity investment and help advise you on your short-term and long-term obligations, along with how it fits with your current estate planning.
How Does This Work?
The nuts and bolts of a home equity investment are relatively simple.
Let's say the current value of a home is now $500,000, and the homeowner decides to tap into the equity of the home to pay for a new pool. After all, like Clark Griswald found out in Christmas Vacation, the days of a company bonus paying for a pool are over.
Refinancing the home can be troublesome, especially if the homeowner's credit is not stellar. Interest rates are high, and the homeowner really can't afford an increase in their mortgage. Likewise, a home equity line of credit includes a new monthly payment, and interest rates are even higher, putting those outside the limits of the homeowner.
Paying with the credit from the pool company? Hopefully, you noticed the extremely high interest rates before signing up.
So, a home equity investment might work for that homeowner.
There are a few companies – backed by venture capital – that offer these types of payments. Those companies pay the homeowner a percentage of your current value, say 10 percent of your home. On the $500,000 home, they would give the homeowner $50,000 for that new pool.
When the homeowner goes to sell their home, or when the term of the investment ends, the homeowner must pay back 20 percent of the value of the home at that time.
Keep in mind, it is virtually impossible to know what that number may be until it's due!
What could the payouts be for a home equity contract?
The basis for the payback is entirely dependent on what the real estate market does in that specific location. If the value of your home increases, your payment increases. If the value of your home goes down, your payment will decrease.
However, in Florida, it is very rare to see home values decrease for an extended period of time. In fact, the average home value in the Orlando area in 2020 was just $269,000, and today, it is nearly $400,000.
Over a 10-year period, if home values increase by 10 percent a year, the homeowner could be required to pay back more than $300,000 with a 10-year term.
With a 30-year term, you could be facing a payment of over $3 million.
Of course, the odds of an annual 10 percent increase are not likely. But just an average 3 percent increase over 30 years could result in a payment of more than $350,000 in exchange for $50,000.
Compare that to a home equity line of credit at today's interest rates. While a homeowner could have a $411 monthly payment on $50,000, the total paid over 30 years would only amount to around $150,000.
A home equity investment can be a substantial amount, so it's important to be wary when signing up for a home equity investment.
Are these tools legitimate?
Yes, these tools are legitimate, however, they were facing increased scrutiny from the Consumer Financial Protection Bureau under President Biden.
At issue was whether they should be treated like a consumer financing option, similar to a mortgage or a car loan, or should they be treated like a financial investment, like securities or stocks.
Remember, when a homeowner signs a mortgage, it seems the paperwork is endless, including forms about discrimination, truth in lending and much more.
Currently, none of that applies to home equity investments.
We're watching a few cases that might help provide guidance on these types of tools.
The government under the prior administration had provided an argument to one case that home equity contracts were a form of financing and should be treated as such.
You can read about that on an archived page found here.
Since taking office, the Trump Administration has taken down all warnings about these financial instruments from the CFPB's website and has had its briefs in cases dealing with these instruments removed as well.
What happens if a homeowner can't pay
For many people, this won't be an issue. It is very rare for a home to depreciate, and often, people downsize when they retire. When those people sell their homes, the payment is included in the sale price.
If that $500,000 home increases in value 10 percent every year, at the end of 30 years, the home's value will be over $6 million. Selling the home will easily cover the payout and still leave the homeowner with millions of dollars.
If that homeowner plans on staying in the home, that means a $3 million payment would have to come from somewhere else, which could be very difficult for many people.
At that point, if the homeowner could not pay, they would be forced to sell the home or have a foreclosure filed against them.
Neither of those options is great for an individual starting retirement.
That is why anyone thinking about entering into a home equity investment needs to work with their estate planning team to determine all the implications for their future.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
