What is a home equity agreement?

A home equity agreement (HEA) is a contract where the homeowner receives a lump sum of cash in exchange for a portion of the home’s future value. You’ll have immediate access to your equity with no monthly payments, but if your home appreciates significantly, the future costs can be high. This article will walk you through how home equity agreements work, the pros and cons, and how they compare to other financing options.

Defining home equity agreement

A home equity agreement – sometimes called a home equity sharing agreement or home equity investment – is a contract between a homeowner and an investor. You’ll receive an upfront, lump sum payment in exchange for a portion of your home’s future appreciation. Unlike a home equity loan or HELOC, that money isn't subject to monthly interest payments.

In exchange, the investor takes out a lien on the property and a predetermined share of the home's appreciated value. You’ll repay the agreement once you sell the home or once the contract ends, typically within 10 to 30 years. The contract also requires the homeowner to maintain the property, keep up with property taxes, and continue paying homeowners insurance.

A home equity agreement allows you to use the equity you've already built as leverage to access cash now. You can use the funds to pay down debt, remodel your home, or make any other major purchase. You won’t have any monthly payments or interest charges, but fees do apply, and the repayment timeline is fixed by the terms of the contract.

What does a home equity agreement involve?

A home equity agreement is a contract that gives you immediate access to a portion of the property’s value. By signing the contract, you’re allowing the investor to take out a lien on your property, which guarantees them a percentage of the future proceeds. You’ll retain ownership of the home, but having a lien on your property can make it harder to sell or refinance before the agreement ends.

If your home doesn't sell within the agreement term, which ranges from 10 to 30 years, you’ll repay the principal along with the investor's agreed-upon share of appreciation. You're also responsible for closing costs at the time of the sale, including title insurance, recording fees, and appraisal charges. If your home's value decreases, the amount you repay decreases as well.

How a home equity agreement works

Once you enter a home equity agreement, the investor pays you a lump sum in exchange for a share of your home's future value. This differs from a home equity loan, where you make monthly payments to repay the loan. With a home equity agreement, that agreed-upon percentage of your home's future value is the investor's return.

If you don't sell within the agreement term, you'll need to arrange another way to repay, such as refinancing or using savings. However, because the lien can complicate the refinancing process, it's worth thinking through your long-term financial plans before signing.

What are the requirements of home equity agreements?

To qualify for a home equity agreement, you'll need to meet certain eligibility requirements. These can vary by investor, but common factors include:

• Home value: Some investors require a minimum home value, while others have a minimum investment amount. The minimum home value can range from $150,000 to $250,000.
• Credit score: HEAs tend to come with low credit score requirements, and you can usually qualify if your credit score is 500 or higher.
• Loan-to-value (LTV) ratio: The exact requirements vary by provider, but most look for an LTV ratio of between 70% and 80%.
• Location: You must be located within the HEA provider’s service area.
• Debt-to-income (DTI) ratio: There's no universal requirement, but home equity agreements are often a good option for those with higher DTI ratios who may not qualify for traditional financing options.

Advantages and disadvantages to home equity agreements

Home equity agreements come with potential upsides and downsides, so you’ll want to weigh the pros and cons to determine if it’s the right option for you.

Pros

• No monthly payments: Unlike traditional financing options, HEAs don’t come with interest charges or monthly payments. This can be helpful if your budget and cash flow are tight.
• Lenient credit score requirements: Some HEA providers require a minimum credit score of 500 or higher. This makes them a good option for individuals with poor credit who want to access their home equity. 
• Funds can be used for anything: When you take out an HEA, there are no restrictions on how you can use the money. The funds can be used for any major purchase, like paying down debt or making home improvements.
• Investor return is capped: Many established HEA providers set a maximum annualized return the investor can earn, which typically ranges from 18% – 20%. That means even if your home appreciates significantly, there's a ceiling on how much equity the investor can collect.

Cons

• Can create tax consequences: Depending on where you live, the money you receive may be taxable. Receiving a large amount of money at once can also make it easy to overspend.
• Closing costs and appraisal fees apply: You'll be responsible for closing costs at the time of sale, which can add up to thousands of dollars. If your home is appraised at a lower value than expected, the investor may also receive a larger share of your equity than anticipated.
• May cost more than other financing options: It's worth running the numbers before signing. Depending on how much your home appreciates, giving up a share of your equity could end up costing more than simply paying interest on a home equity loan or HELOC.
• Structured as a balloon payment: At the end of the agreement term, you'll owe a large lump-sum payment to the investor, whether you've sold your home or not. If you haven't sold it, you'll need to arrange another way to cover it, like through refinancing or using savings.

How to choose a home equity agreement company

1. Shop around

The terms of your home equity agreement can vary significantly depending on your provider. Before agreeing to a contract, compare offers from multiple investors and pay close attention to:

• Amount of equity requested
• Lump sum offered
• Length of the agreement term
• Eligibility requirements
• Fees and closing costs
• Whether funds will be taxable
• Whether a prepayment penalty applies

2. Ask the right questions

As you review each provider, make sure you understand exactly what you're agreeing to. Here are some questions you can ask:

• How is the home’s future value determined, and who conducts the appraisal?
• Is the investor’s return capped, and at what percentage?
• What happens if I want to sell or refinance before the term ends?
• What are my options at the end of the term if I haven't sold?

3. Think about the future

The right home equity agreement depends on your individual financial situation and your ability to meet the repayment obligations down the road. Before signing, consider your future income, the health of your local real estate market, and how you'd handle the balloon payment at the end of the term, whether through a home sale, refinancing, or other savings.

What are alternatives to home equity agreements?

If a home equity agreement doesn't feel like the right fit, there are several other ways to access your home equity:

• Home equity loan: A home equity loan lets you borrow against your home equity and receive it as a lump sum payment. You’ll repay the loan in monthly installments in addition to your regular mortgage payment. The overall cost may be lower than giving up a share of your home's equity, but you'll need to qualify based on your credit score and income.
• HELOCs: A HELOC gives you a revolving line of credit secured by your home. You can draw on it as needed during a set draw period, typically 10 years, making interest-only payments as you go. After that, a repayment period begins, and both principal and interest come due. A HELOC requires regular payments but may cost less overall than a home equity agreement.
• Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new, larger loan, and you’ll receive the difference as cash. You'll have one updated monthly payment, but you'll also be taking on a larger mortgage balance. And a cash-out refinance may not be the right option if you already have a low interest rate.
• Reverse mortgage: A reverse mortgage is available to homeowners aged 62 and older. It allows you to tap your home equity without making monthly payments, and repayment is deferred until you sell the home, move out, or pass away.

The bottom line: A home equity agreement may be right for you

A home equity agreement is a way to access your home equity now in exchange for a share of your home's future appreciation. An HEA can be a good fit for homeowners who need cash but have lower credit scores or don't qualify for traditional financing.

That said, if your home appreciates significantly, the cost can be high, so it's worth comparing your options before moving forward. If you’re ready to explore your home equity options, you can start your mortgage approval application today.