What is a Home Equity Agreement? Pros & Cons

Updated for accuracy and relevancy on June 18th, 2024

As we’ve discussed in previous articles, there are many ways for a qualifying homeowner to tap into their home equity to build wealth –– whether it’s to tackle some much-needed renovations, pay off high-interest debts, finance large purchases, or simply free up some spending cash. Home equity loans, home equity line of credit (HELOC), and reverse mortgages are three common options, though credit and equity requirements can be limiting factors for some homeowners. When considering a HELOC vs. home equity loan, it’s important to know that both pathways also require prompt repayment; one extra bill is likely the last thing many cash-strapped homeowners are looking for. While reverse mortgages do not require monthly payments, they can lead to the accrual of significant interest and fees over time, potentially diminishing the estate value for heirs. 

Enter: The home equity agreement (also known as a shared equity agreement), a tool for the homeowner to access a portion of their home equity by allowing lenders to invest directly in the home or real estate property. A shared equity loan allows homeowners to access a portion of their home equity without taking on traditional debt. In exchange for a partial ownership stake, homeowners receive a chunk of equity from the investor in question, in exchange for a percentage of the future home value, known as an equity share. With the housing markets in certain parts of the country showing no signs of slowing, betting on that value seeing a boost can appear far safer than a trip around the roulette wheel –– for lenders, at least.  

For those who may be rebuilding their credit (HELOCs and home equity loans require a minimum credit score of 620) or prefer to avoid taking on potentially high-interest debt, a home equity agreement may be the better option, especially compared to a reverse mortgage. But before you make up your mind, let’s take a closer look at how a shared equity mortgage works. 

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How Does an Equity Agreement Work? 

Before an outside party makes the decision to invest in your real estate property, they’ll want to know what their investment is worth –– and what a potential payout might look like. So, the shared equity agreement process will start with a home appraisal to determine the current property value. Are you familiar with how to calculate home equity?

In this scenario, let's say you own a home that is currently worth $500,000 and you have an outstanding mortgage balance of $200,000. This means you have $300,000 in home equity, and a shared equity agreement allows you to free up a percentage of this equity. Fairly simple math, sure, but with this financial tool it gets a bit more complex. See, when you enter into a home equity agreement with a lender or investor, you’re tapping into your home equity without signing on for a high-interest loan. 

And in place of this interest, you agree to pay the lender a percentage of your home’s appreciation at the end of the equity sharing agreement term, making it different from a traditional loan. If the home value decreases over this timespan, the amount you might owe will be reduced –– but so will your overall home equity.1,2 But if your home’s value skyrockets (like it might have in the last few years), you can end up owing a lender a tidy sum.

Ending a Home Equity Agreement (HEA) before its term is possible by either repurchasing the provider's equity or selling the property. Should you opt to terminate the agreement early, buying out the provider's equity entirely is one avenue available. However, if immediate full payment isn't feasible, there's often the option to purchase portions of the agreement gradually over time. This gradual buyback approach allows for flexibility, enabling individuals to manage the buyout in stages if immediate full repayment isn't financially viable. Whether through a lump-sum payment or staggered buybacks, terminating the HEA provides an exit strategy that accommodates different financial circumstances, ensuring a means to end the agreement before its intended duration. The fee for paying off a HELOC early can differ from one lender to another, usually staying within a range of a few hundred dollars. This fee might be a set amount or a percentage of the remaining balance, capped at a specific maximum limit.

At the end of the agreement term, typically between 10 and 30 years², or when you decide to sell the home, you’re obligated to pay the lender back the home equity you “borrowed” in addition to this increase in value. Until And until you pay them back, the lender technically owns a portion of your home. No, they can’t move their things in and start hogging all the hot water.  But if the mere idea of someone other than you and your household owning a portion of your home rubs you the wrong way, a homeshared equity agreement might not be right for you. 

Are Shared Equity Agreements Worth It? 

Whether a shared equity agreement is worth it depends entirely on your individual financial circumstances and goals. Below are some of the pros and cons to consider when deciding whether a home equity agreement is right for you:

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Pros:

• Fast Access to Cash – When times are tough or major home renovation products are on the horizon, a shared equity agreement can be a great way to access a large chunk of cash, fast. And compared to maxing out a high-interest credit card or pursuing a home equity loan or HELOC, a home equity agreement can seem like the more accessible option. While financial hardship can be a good reason for some homeowners to dip into home equity, a home equity agreement really begins to make sense when equity is used to improve the home’s value –– helping to replenish your home equity and drive up the eventual sale price. But be warned: The higher the sale price, the bigger your payout to a lender will be. 

• No Monthly Payments – Unlike a home equity loan, you typically won't have to make a monthly payment on a home equity agreement until the end of the agreement term or you sell the home (whichever comes first.) This can be good for homeowners who are using home equity to cover day-to-day expenses, especially compared to credit cards or HELOCs which can end up adding to the growing list of bills to pay. 
• Not Taxable as Income: Shared equity contracts, such as home equity agreements, often offer a lump sum payment to homeowners without taxing it as income. However, the tax implications of these agreements can vary based on location. While the initial lump sum isn't generally considered taxable income, it's essential to be aware that certain states, counties, or cities might have regulations that require homeowners to pay taxes related to these arrangements. The taxation specifics linked to home equity agreements can vary, making it crucial for individuals considering such contracts to investigate and understand the local tax implications to ensure full compliance with relevant tax laws.‍
• No Interest Charges – Since a shared equity agreement is not a loan, there are no affiliated interest charges –– making this a strong option if you’re looking for cash without obscene interest fees. With that said, by entering into a home equity agreement you are agreeing to pay a lender a sizable chunk of your home’s appreciation. And in some cases, this payout may (far) exceed that of a decade’s worth of interest. 

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Cons:

• Reduced Equity – This might go without saying, but by selling a portion of your home equity, you are reducing the amount of money you will receive when you eventually sell your home. Obvious, maybe, but many homeowners may have their judgment clouded by the idea of “free money” and forget that this money isn’t free at all –– it’s the product of years (and years) of on-time mortgage payments. Homeowners with plans to move up the property ladder or use home equity to fund retirement plans should think critically about whether this equity hit is worth it. 

• It’s Not Cheap – Because the risk of the home equity investment is factored into the percentage of market value homeowners will receive, borrowers will more than likely take a financial hit as soon as they access this equity. And should the value of your home skyrocket, your repayment to a lender could end up being sizable. But before you even access your home’s equity, you may find yourself faced with thousands of dollars in administrative and appraisal fees, making the buy-in alone for this process too costly for some. 

• One-Time Repayment – Because repayment through a shared equity agreement typically comes in the form of one lump sum, homeowners miss out on burdensome monthly payments. But what they get in return is a potentially massive balance when the agreement term ends. And if you don’t have upwards of $50,000 lying around (plus any appreciation) when the bill comes due? In that case, you may be forced to sell the investment property –– whether moving was in your plans or not. Whether you sign on for a 10-year or 30-year term, know that repayment will arrive sooner than you think. 

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The Bottom Line

Overall, shared equity agreements can be a solid option for homeowners who want to access instant cash without having to sell their homes or take on additional debt, but this cash can come at a hefty price. Therefore, it’s important to carefully consider the costs and benefits of any home equity agreement and to seek the advice of a financial or legal professional before signing on the dotted line.

Interested in other ways to access your home’s equity? Brush up on Truehold’s Sale-Leaseback and visit our resource library to learn more.

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Sources: 

1. Consumer Affairs. What is a home equity sharing agreement?  https://www.consumeraffairs.com/finance/what-is-a-home-equity-sharing-agreement.html 

2. Nerdwallet. What Is a Home Equity Sharing Agreement? https://www.nerdwallet.com/article/mortgages/shared-appreciation-home-equity

3. How a HEA Works: Home Equity Agreements Made Easy https://www.unlock.com/blog/home-equity/how-a-hea-works-home-equity-agreements-made-easy/