Money Girl

Should I Get a Home Equity Investment Loan?

Episode Summary

Laura answers a listener's question about getting a home equity investment loan to retire early.

Episode Notes

Laura answers a listener's question about getting a home equity investment loan to retire early.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

Welcome back to Finance Friday, another special edition of Money Girl, where I answer

your burning money questions! Today's topic comes from Joel H., who says:

"Love the show–so much good advice! I just learned about a "home equity investment," where you receive a portion of your home equity with no monthly payments. I'm 59.5, and my wife is 51. We have a sizable amount of equity, 75% of a $2.8 million house, and I've been told we could get a home equity investment loan for up to $500,000. I don't need the funds now, but I think it could be a way to help me retire early.

While we have about $3 million in retirement funds, we live in the Bay Area and still have teenagers in school, so it's not enough to retire yet. Is getting a home equity investment loan too good to be true?"

Thanks for your great question, Joel! I'll review the pros and cons of getting a home equity investment loan and how it differs from some other options to tap the value of your home.

Thanks for downloading episode 927 of the Money Girl podcast! I'm Laura Adams, an award-winning author, money speaker, on-camera spokesperson, and founder of The Money Stack, a Substack newsletter. You can subscribe for free or become a paid member with access to live educational events!

You can learn more and connect with me at LauraDAdams.com. That's also where you can email your money question, learn more about my books and courses, and sign up for The Money Stack. You can also record a brief question or comment on our voicemail

line at 302-364-0308.

What is a home equity investment loan?

You've probably heard of a home equity line of credit (HELOC) or loan allowing you to borrow against your home equity. Equity is the difference between your home's current value and any debt you owe, such as a first and second mortgage. For instance, if your home is worth $500,000 and you owe $400,000, you have $100,000 of equity.

A home equity investment or HEI, which is also known as a home equity sharing agreement, is a contract with an investment company that allows you to receive an upfront payment in exchange for a portion of your home's future appreciation or value.

With an HEI, you sell a stake in your home's future value. The investor shares in your home's potential appreciation or depreciation. If your property value increases significantly, you may pay the investor more over the long run than with a traditional loan.

Unlike a traditional loan, where you make monthly payments that include interest, with an HEI, there are no payments. Instead, you agree to repay the original loan amount plus a share of your home's value at a later date.

For instance, if you repay the investment within five years, you might have to pay 15% of your home's value or 20% after ten years. Let's say your $500,000 house is worth $600,000 after five years and $700,000 after ten years of taking an HEI.

In this example, if you settled up after five years, you'd owe the principal amount plus 15% of $600,000, or $90,000. After ten years, you'd owe the principal plus 20% of $700,000, or $140,000.

If your home depreciates, you still must pay a set percentage of your home's value, such as 15%. Some HEIs have a set expiration date for repayment, while others must be repaid when you sell or refinance your home.

What are the pros of a home equity investment loan?

Here are the main pros for taking a home equity investment loan.

You don't make monthly payments: Not worrying about making payments could be a lifesaver if you're experiencing financial hardship or need more monthly cash flow. You owe nothing for an HEI until the term expires or you decide to sell or refinance your home.
You don't need good finances: Since an HEI is an investment in your home, you may qualify even if you have no or low income, poor credit, or a high level of debt.
You can tap a large amount of equity: Depending on your home value and equity, some HEIs may pay up to $500,000, as Joel mentioned.
You can use the funds any way you wish: You can save HEI funds or spend them on anything you like, including living expenses, medical bills, home renovations, education, or a vacation.
You have an extended repayment term: Different HEI companies offer different terms ranging from 10 to 30 years and typically have no prepayment penalties.

What are the cons of a home equity investment loan?

Joel asked if getting an HEI is too good to be true. Here are some downsides to consider.

You must share a significant portion of your home's price or appreciation: In exchange for getting a lump sum of cash from an investor, you agree to share a hefty portion of your home's future value or appreciation, no matter if it goes up or down. Different HEI companies have different calculations and fee schedules, so be sure you understand them.
You may not get funds quickly: Since your home secures an HEI, the investor will require an appraisal and perhaps other documentation. That means it could take longer than a traditional loan, such as an unsecured personal loan.
Your property may not qualify: HEIs may not be available in your state or for your type of property.
You risk foreclosure: Like a loan secured by your home, if you don't repay an HEI at the end of the term, you risk losing it to foreclosure.
Your future cost is uncertain: Unlike a fixed-rate loan, with an HEI, you won't know what you owe until you're ready to repay it and know the value of your home. However, some companies include caps that prevent you from repaying too much if your home appreciates significantly.

LISTEN ALSO: Pros and cons of a home equity line of credit (HELOC)

Should I get a home equity investment loan?

Since Joel doesn't sound like he's experiencing financial hardship, I don't recommend he get a home equity investment loan. There are less expensive ways to tap his home equity.

For instance, if he took out a home equity line of credit (HELOC), that would give him the ability to tap his equity without sharing a large chunk of his home's future value or appreciation. While a HELOC does come with interest and closing costs, it would likely add up to be lower than the cost of an HEI. The going interest rate on a HELOC is about 6% to 7%.

With a HELOC, you can tap any amount, up to your available limit, at any time. That could give Joel a safety net if he decides to retire early.

Another option for Joel is to wait until age 62 and get a reverse mortgage. It allows you to take a loan or line of credit based on your home's equity.

Like an HEI, you don't make monthly payments on a reverse mortgage. However, you don't share any of your home's future equity. A reverse mortgage must be repaid when you move out, sell, or refinance your home.

A home equity investment loan is primarily a good fit when you need to tap a large amount of your home's equity but can't get traditional financing because you have low income, high debt, or poor credit. Since the future cost of an HEI is unknown or likely to be more expensive than other options, it's probably not right for Joel.

If you're thinking about tapping your home equity, do your homework to compare the cost of various options, including getting a home equity loan or line of credit, refinancing, taking out a reverse mortgage (if you're over 62), or agreeing to a home equity investment. No matter your situation, try to borrow money for the lowest total cost possible.

The best money move depends on your home value, equity, finances, and goals. Remember that if you plan to use borrowed funds to buy, build, or remodel a home, interest paid on up to a certain amount of a home equity loan or line of credit is tax-deductible.

Joel, I appreciate your question and agree that your considerable home equity can be part of your retirement planning. Carefully compare your options for tapping it, and consider getting advice from a certified financial planner. They may have additional ideas for creating a financial safety net and income if you want an early retirement.

Before we go, here's a quick reminder to subscribe to The Money Stack, my Substack newsletter, when you visit LauraDAdams.com. It's filled with money tips, tools, news, challenges, and things I enjoy! You can subscribe for free or become a paid member with access to live educational events.

That's all for now. I'll talk to you soon. Until then, here's to living a richer life!

Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, and Nathaniel Hoopes is our marketing contractor.