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In the wake of high inflation, rising interest rates and a slowing economy, cost of living pressures are front of mind for many Australians. Financial stress can be powerfully disruptive, and in times like these even homeowners earning a good living can feel trapped by mounting mortgage repayments and other debt costs.
Historically, homeowners haven’t had many options to leverage their home as a financial resource, but that is slowly starting to change. Rather than keeping wealth locked up in their properties, homeowners may want to examine the role of their home as an accessible source of capital and factor it into their long-term financial planning.
That's where home equity agreements (HEA) can help.
Home equity agreements provide a way to leverage the equity in your home to help you meet your financial goals. Whether you’re looking to get those long-awaited renovations done, pay off other debt, start a business or make a large purchase, a home equity agreement can be an attractive solution.
Keep reading to learn what a home equity agreement is, how it works and the pros and cons worth considering.
A home equity agreement, also known as home equity sharing, home equity sharing agreement, or home equity investment, is a financial arrangement between a property owner and an HEA provider. This agreement enables homeowners to unlock some of the equity they've accrued in their homes.
This arrangement diverges from home equity loans and lines of credit as it does not involve monthly debt or interest payments.
Instead, you can receive a lump-sum payment by agreeing to share a percentage of any increases in the home’s value over time. This means there are no monthly principal or interest repayments. Instead, the homeowner agrees to repay the received amount plus a predetermined share of the equity within a specific time frame or when the property sells. This is typically when you sell your home, refinance, or the agreement’s term ends. Similar to a traditional loan you will also be required to grant the HEA provider a security on your property.
It’s important to note that during the term of the agreement homeowners will:
HEAs serve as an alternative to conventional borrowing options like home equity loans or mortgage refinancing. However, understanding the advantages and disadvantages of home equity sharing is crucial, as these arrangements have their unique pros and cons. Seeking advice from a financial or legal expert is recommended to ensure that an HEA matches your financial requirements and objectives.
To illustrate how a home equity agreement works, here's a typical example:
Let’s say your home has an appraised value of $500,000, and you enter into a contract with one of the HEA providers on the market. They agree to provide a lump sum of $50,000 in exchange for 20% of your home’s appreciation.
Then let's say you want to sell the home or buy back the share from the HEA provider in 5 years time.
If the property increases in value by, say, $200,000 over the next 10 years, you would be responsible for repaying the initial $50,000, plus 20% of the $200,000 gain — or an extra $40,000.
If the property value remains constant or goes down, typically the home equity provider would only recoup the original amount received. There may also be discharge or ancillary fees.
Engaging in a home equity agreement can yield several benefits for a homeowner, including:
HEAs, as opposed to traditional borrowing mechanisms like loans or mortgage refinancing, do not require monthly payments. This offers a clear benefit for homeowners with restricted cash flow or those not willing to shoulder additional debt.
HEAs typically have more flexible credit history prerequisites than conventional loans. This makes HEAs an appealing option for homeowners that might have limited access to more traditional finance options.
The capital derived from HEAs can usually be utilised freely, allowing homeowners to spend the funds on home upgrades, debt consolidation, or even leisure travel. However, it’s important to check the loan agreement for any restrictions.
Despite its advantages, certain risks associated with home equity agreements must be considered before a homeowner relinquishes a share of their home equity. These include:
HEAs usually offer a lump sum payment which can be very tempting to spend. It’s critical for homeowners to ensure their spending aligns with their bigger financial goals and meets any conditions set out in the HEA contract.
Importantly, homeowners should contemplate the extent of home equity being surrendered and ensure the accuracy of the home's appraised value. A low appraisal might result in the investment company receiving a more significant equity share than warranted, leading to substantial future costs for the homeowner.
The expenses associated with an HEA could be considerable, depending on the home's value appreciation. The HEA provider receives a share of your home's future value, meaning if your home appreciates, the initial cash payment plus a share in the appreciation must be repaid.
If the home's value remains stagnant, at a minimum you'll need to repay the drawn equity. Even though you can sell your home at any point, depending on the HEA provider, there may be discharge and ancillary fees. This ultimately depends on your agreement with the HEA provider. It's crucial to thoroughly research and compare the pricing structures, including fees and policies, of various HEA providers before entering an agreement.
A Home Equity Agreement is an alternative to traditional methods of borrowing. There are no monthly payments or interest charges, typically more lenient credit requirements and additional flexibility on how you can use the funds.
It’s always important to consider the risks associated with any lending product but these types of solutions could provide an opportunity for more Australian homeowners to meet their financial goals.
If you’d like to speak with our team to learn more about Home Equity Agreements, we’d love to hear from you.
It’s very similar. The term “shared equity scheme” is typically used when talking about government funded programs that aim to provide financial assistance to first home buyers, low income households and pensioners. The government will fund a portion of the purchase price of a new home and in return the government is entitled to a percentage of the equity in that home.
There have been many different versions of these government backed schemes in Australia and overseas over the last 20-30 years. More recently though, in the United States, private companies have built similar style solutions to help basically any homeowner, not only first home buyers, low income households or pensioners. These private companies are able to provide additional benefits and features to homeowners that governments cannot, or do not, offer.
It is good to see private companies stepping in with innovative solutions to help new and existing homeowners and we’re excited to see these types of solutions coming to the Australian market.
Home equity agreements and reverse mortgages both allow a homeowner to access the equity in their home without adding additional monthly debt repayments.
There are a number of differences between these types of products, however, the key one being how the interest on the loan is calculated:
The other major differences are:
Most HEAs provide total flexibility on what you can do to your home. These agreements are not meant to restrict what you can do with your home.
Each HEA provider will provide their own terms in the contract that sets out how the property will be assessed before and after the renovations to determine how much equity the renovations have added. In most instances, you will then be able to request an adjustment to the agreed home value to account for any appreciation in the value of the property as a result of certain qualified renovations.
There are some scenarios where an HEA may not be suitable, such as:
Scenarios where the ‘cost’ to the customer of an HEA may be more than traditional forms of credit include:
As always, before entering into an HEA you should consider the risks and compare any fees and terms to understand whether this type of arrangement is right for you. We recommend you seek appropriate professional advice.
Things you should know
OpenAgent Pty Ltd is not making any suggestion or recommendation about any particular product or strategy. The information provided constitutes information which is general in nature and has not taken into account any of your personal objectives, financial situation, or needs. Before basing any decisions on this information please:
All examples and scenarios are illustrative only. This blog is subject to change without notice.
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