The Wall Street Journal recently featured a new mortgage product that allows borrowers to pledge their future equity in exchange for a loan today. It works like this: The finance company advances you money–usually 10 to 15% of the current value of your home, and when you sell it, the investor gets half of the property’s appreciation.
Some require that you pay back the initial advance while others do not. All investors require that you keep the property maintained and pay your taxes, and you can’t sell it for a minimum number of years (usually 5) without paying a hefty penalty. Additionally, you cannot take on more home equity debt or refinance without approval. The good thing is that if your home doesn’t increase in value you are not penalized and in some cases won’t even have to pay the loan back!
So, if you need money desperately and have no equity, this loan could save your life. Otherwise, it might be a really, really expensive way to borrow. Consider the following “what-if:”
A borrower with a $500,000 home and no equity could borrow $50,000 with this product, called a shared appreciation loan. In ten years, the home could be worth $750,000 (at less than 5% annual appreciation this is not an unrealistic scenario). Well, the owner sells the home and has to repay the $50,000–and an additional $125,000, for a total of $175,000 to borrow $50,000 for ten years. If one invested that $50,000, it would have to earn a return of nearly 13% to break even! Most would find 13% pretty spendy for a mortgage loan. But it’s still cheaper than most credit card loans, many small business loans, or private student loans.
And it could make home value depreciation almost a good thing….
- |
- |
-
(23 votes, average: 4.91 out of 5)
Loading ...
What other fees are associated with this type of loan?
The main costs for this loan is the appreciation you give up. Origination fees range from zero to a few hundred dollars, mainly the cost of an appraisal. Some companies charge more depending on the loan to value they are willing to accept, or other factors–max fees are about 3%. One thing I’d look out for if I were considering this kind of loan is the appraisal–the firms undoubtedly require their own appraiser or one they have approved, which could result in a lower value than an independent professional would give. I’d make sure the value was accurate because if it’s understated then the appreciation becomes overstated and I pay more when I sell the property. A $25,000 difference means an extra $12,500 out of my pocket so it’s important.
What are the qualifications to get such a loan. Is this similar to a reverse mortgage? Do you have to be older?
What happens to the lender if the a client dies before his or her property has appreciated?
Gary, qualifications cAn be a little different. Some lenders put age restrictions on their products but not all do. Most put geographic restrictions–you can’t get this loan in an area experiencing rapidly declining values. One company, Equity Key, only allows borrowers from age 65 to 85 and actually purchases a life insurance policy on every borrower, so if you aren’t healthy enough you can’t get the loan. Which brings me to…
Fred, what happens when you die also depends on which company you use. Equity Key doesn’t make your heirs pay the loan because it gets paid with a life insurance policy. Other companies will make your heirs repay the loan plus its share of any appreciation that has occured.
Hi Gina,
It is difficult to believe that with our current mortgage crisis that lenders/investors are willing to lend, once again, on potential raises in home equity values. Don’t they ever learn?!? Any idea of how they are going to show these “assets” on their books?
Thanks, S
Funnily, research showed that these companies are targeting some of the most beaten-down markets (not permanently beaten like Flint, MI but more bouncy like Sacramento, CA), assuming I guess that the bulk of the depreciation is done and that in the next few years they’ll catch a nice bounce. If this is a leading indicator it’s encouraging. The real estate industry can’t be wrong EVERY time it crows, “It’s a Great Time to Buy!”
Hi Sheryl,
Regarding how these would look on the lenders’financial statements, GAAP says that the principal balance is an asset, the fees are income, and because there is no set maturity for cashing out there would have to be unrealized gains / losses booked periodically. Not sure how the prepayment penalties show up–they can be has high as 30% of the balance loaned in year 1 and dropping to zero at year 5. However, according to the National Council of Real Estate Investment Fiduciaries applicable prepayment penalties ahould count as part of the unrealized value of securities when they are revalued.
New information about this product! A representative at Equity Key informed me that they don’t pull your credit report when underwriting your loan! And those with bad credit don’t pay any more than borrowers with excellent credit.
One caviat: They will check public information–so if you are default on your mortgage or have tax liens, mechanics’ liens, or other claims against the property you can’t get this loan. They also want a current mortgage statement showing that you are current on your home loan.