What is a Home Equity Agreement and How Does It Work? (2024 Guide) (2024)

What Is a Home Equity Agreement?

Home equity is the portion of the homeowner’s property they own outright, calculated as the property’s current market value minus any outstanding mortgage balances.

The structure of a HEA is a little complicated, but basically it works like this: A HEA company agrees to give you a lump sum of cash based on the value of your home and the equity you have in it right now. Then, when you go to sell the home, you agree to pay back a fixed percentage of the home’s appreciation between now and then – often as high as 40%.

HEAs typically have an end date of 10 to 30 years if you don’t sell the home. You’ll owe the money at this point, often requiring you to take out a traditional home equity loan to pay it back.

How Do Home Equity Agreements Work?

The application process for an HEA is similar to that of a traditional home equity loan, but qualification requirements tend to be much less stringent. HEA providers often require proof of home ownership and a certain percentage of home equity — typically 30% or higher.

During the approval process, the financial institution or private investor will appraise your property to determine the value of your home. Because HEA providers are financially rewarded if your home increases in value, some may apply a reduction to your home’s appraised value, which ensures they start the agreement already making a profit.

After approval, you receive a lump-sum payment upfront – minus an origination fee. You will have to repay the funds along with a fixed percentage of your home’s appreciation at the home’s sale or at the end of the agreement, which typically ranges from 10 to 30 years.

Here is a quick overview of how HEAs work:

• The provider ensures you meet its eligibility requirements
• The provider requires an appraisal to assess your home’s value
• If approved, you’ll typically need to sign the paperwork, pay the closing costs and then receive a lump-sum payment upfront
• Upon sale of the home or at the end of the agreement term, the HEA provider or investor gets a fixed percentage of your home’s appreciation

Who Are Home Equity Agreements Best For?

When compared to traditional types of loans — such as personal loans, mortgages or home equity loans — HEAs may be beneficial for some homeowners.

As HEAs do not require monthly payments, lenders may be more lenient regarding your income and credit history. This improves your chances of approval if you have less-than-ideal creditworthiness and/or a high debt-to-income (DTI) ratio, which may prevent you from qualifying for traditional loans. DTI measures your monthly income against your monthly debt obligations.

If a homeowner has limited or irregular income, HEAs may also be a helpful option to consider. Inconsistency in income not only reduces your eligibility for traditional loans, but can make it difficult to manage recurring payments. If you have a variable or limited cash flow, HEAs can help you access equity you may not be immediately able to otherwise.

Pros and Cons of Home Equity Agreements

As with any financial agreement, HEAs have various advantages and disadvantages you should consider before signing.

How Much Does a Home Equity Agreement Cost?

The costs associated with HEAs vary according to how much equity you have in your home in addition to the costs and fees applied by different providers.

HEA companies may charge an origination fee of between 3% and 5%. Along with the origination fee, you may have to pay a few thousand dollars to cover the administrative costs in addition to the home appraisal and other legal fees.

For example, if you have $200,000 in equity on a $300,000 property, you qualify for $50,000 in funding. With 4% required for just origination, your upfront costs would start at around $2,000, not including the appraisal and legal costs.

At the end of the term or during the sale, it is very likely you would pay a percentage of the appreciation. For example, a promise to pay 40% of the appreciation on a home that increases $300,000 in value would mean owing $120,000 to the private investor.

These costs may be considerably different from other alternatives available to you. For example, the interest rates and fees when using revolving credit, such as a 30-year home equity line of credit (HELOC) with a 10-year draw period, a 20-year repayment period and a 10% annual percentage rate (APR), could cost less than $5,000, provided that you spend a small amount and repay it quickly. APR represents the true cost of a loan, both interest rates and fees.

On the other hand, a traditional loan, such as a home equity loan with a 7% APR on a $50,000 loan with a 30-year term, could cost an additional $70,000 in interest and fees.

Understanding the Terms of HEAs

When reviewing HEAs, it’s important to understand the typical terms and conditions.

A good place to start is with the appreciation value, which is how HEA providers and investors primarily profit from your agreement. For example, say that you’re a homeowner who signed an HEA to pay 15% of the appreciated value of your home. The home was initially valued at $200,000, and the home has increased to $350,000 — a $150,000 appreciation. You could owe $22,500 at the time of sale or the end of the agreement timeline along with the original borrowed amount, under standard terms.

In addition to origination fees and other upfront costs, HEAs may limit what a homeowner can do with the property. An HEA may require you to continue living at the property and/or to request approval for home improvements or modifications to the property.

Steps for Getting a Home Equity Agreement

While there are similarities between applying for an HEA and a traditional loan, there are a few key differences. For one, HEAs are usually not available from traditional home equity loan lenders but instead from private providers or investors.

The following steps can help you obtain an HEA:

1. Check eligibility requirements: Be sure to review the eligibility criteria as these may vary by lender.
2. Request quotes from multiple providers: Shop around when considering HEAs to ensure you get the best offer for what you need.
3. Compare all offers and terms: Review the terms and details of all offers, including the percentage of funds that will be provided, any limits that apply to renovating or repairing the home, the length of the agreement, when repayment is required and the percentage of appreciated value required at repayment.
4. Consult professionals: To avoid any end-of-term surprises and to ensure you know what you’re getting into, consider consulting with a credible lawyer, accountant or financial advisor about your HEA before agreeing to the terms.
5. Negotiate terms if possible: Just as you can negotiate on home equity and HELOC loans, lenders may allow you to negotiate the fees for your home equity agreement. Consider doing so before signing an agreement.
6. Review the agreement thoroughly before signing: Be sure you understand all the requirements and limitations as well as what to expect throughout the agreement.

Key Differences Between HEAs and Home Equity Loans

The table below details somekey distinctions that you should keep in mind when evaluating HEAs as compared to home equity loans.

Home Equity Agreement Alternatives

In addition to home equity loans, other alternatives to HEAs include HELOCs, reverse mortgages, personal loans and cash-out refinancing.

If you take out a HELOC, you gain access to a revolving line of credit against the equity in your home that you can continue drawing from as long as there is an available balance. You can increase that available balance by repaying previously borrowed amounts. A reverse mortgage allows borrowers to access the equity in the home as long as you continue to live there.

You could also consider taking out a personal secured or unsecured loan, which comes with monthly repayment schedules and potentially a lower risk to home equity (specifically for unsecured loans). Cash-out refinance is another alternative, which involves replacing your existing mortgage with a higher mortgage loan and cashing out the difference between the two.

The Bottom Line

HEAs are usually easier to qualify for than many traditional options that allow you to use your equity to access funds. While there are no monthly payments required, you may find yourself owing a substantial amount of your home’s future equity. If you have a good credit score and low debt, you may want to consider alternatives such as HELOCs, personal loans and cash-out refinancing.

Overall, be thorough when shopping around and comparing terms for your funding options, and consider speaking with a lawyer and a financial expert. Weighing the pros and cons of each financing option can help you determine the right choice for you, now and in the future.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.