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??.
