New idea to free up equity has drawbacks

By: Kenneth R. Harney Home Loans 2 Followers

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When an investor offers you $50,000 or $100,000 in exchange for 30 percent to 50 percent of your home's future appreciation, is it a good deal?

That's what a new breed of investment firms is promoting as an alternative to traditional home equity loans, lines of credit and reverse mortgages. The companies argue that sharing future value increases is a superior way to convert current equity into spendable money now because there are no monthly payments or interest charges, fees are comparatively low, and investors agree to participate in losses in a home's value as well as in gains.

Two of the investment companies – REX & Co. and Grander Financial – are specifically targeting owners in their 50s and younger who are ineligible for reverse mortgage programs that are restricted to individuals 62 and older.

But are there drawbacks in the details that homeowners need to consider? Absolutely. Start with the core concept of “no interest” being charged on the lump-sum amounts of money homeowners receive. Is $50,000 today in exchange for half of all future appreciation on a hypothetical $500,000 house worth it?

Maybe, especially if values are likely to remain flat, decline or increase minimally. But consider this scenario over an extended period, say eight to 10 years.

Assume your house increases in value by $250,000 or 50 percent and is worth $750,000 when you want to terminate the agreement and sell. You've had full use of the $50,000 during the years without paying a dollar of interest. Now you must pay back the $50,000 plus 50 percent of the appreciation – $125,000 – to the investor from the proceeds.

That may suit you just fine. Ignoring selling expenses and any existing mortgage debt, you net $575,000 because you owe $175,000 to the investor ($50,000 plus $125,000). For a $50,000 cash advance, you've given up $125,000. Your house increased in value by 50 percent, but look at the investor's return: The $50,000 advance has leveraged $125,000 – well over double.

This may not be “interest” in the terminology preferred by the investors, but it's definitely a “yield” on their capital – and a good one at that. The investors' return on a relatively small advance of money is magnified over extended periods of time because it's tied to the value changes of a far larger asset – the entire house.

In fairness, there's risk to the investor as well. If your home value drops during that extended period, the investors suffer a loss proportional to their stake in the home's change in value during the agreement.

Some other considerations: Poke around the offering documents of these new programs and you find restrictions that shouldn't be ignored.

Take the equivalent of a prepayment penalty for sales of properties within the first five years. In the REX and Grander Financial contracts, the penalty is 25 percent of the amount of the original advance in year one, 20 percent in year two, 15 percent during year three, 10 percent in year four and 5 percent in year five.

After that, there's no penalty for selling the house or terminating the agreement. On a $100,000 advance when the house is sold in year one, the homeowners would owe $125,000 plus any appreciation gain.

There's a potentially troublesome “deferred maintenance adjustment” clause in the REX agreement, which is also used by Grander Financial. The investors have the legal right, based on an “independent, third-party” appraisal or inspection, to claim additional payments at sale “to reflect any maintenance that should have been performed when the agreement was in effect.” The words “should have” are subjective enough to cause some serious disagreements between owners and investors.

Take note, too, that the agreements give the investors the right to limit the “maximum authorized debt” on your home once you've pocketed an advance. That includes credit lines, second loans and first mortgages secured by the property.

Whatever the sponsors choose to call their products – they are adamant that they are not “loans” – they provide investors with a security instrument that constitutes a publicly recorded lien against the property similar to a deed of trust or mortgage.

Finally, in evaluating these products, bear this in mind: Because equity investment agreements without age restrictions are new, they receive little or no regulatory scrutiny at the federal or state levels. REX & Co. managing director Tjarko Leifer says his firm would welcome regulation and uniform standards as the industry expands.

But the reality is: It's not there at the moment. Consumers need to thoroughly understand what they're getting into.

Ken Harney's e-mail address is


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