No one’s talking about a dangerous new US housing trend. Why home equity agreements could trigger disaster for millions
For starters, the up-front cash payment often involves a fee for the homeowner, often 3% to 5%, according to CFPB. That reduces the amount of cash you actually receive. Meanwhile, the contract often involves several features to protect the issuer from downside risks. For instance, the multiplier used to calculate settlement is often higher than the ratio of home equity the homeowner gets paid for.
For example, notes CFPB, a homeowner could sign an agreement to receive cash for 10% of their home’s equity but the contract applies a 2x multiplier, which means they must pay 20% of the home’s long-term appreciation (2). Not only is such an arrangement unfavorable for the homeowner, it also means the home would have to lose significant value before the issuer faces any losses.
Some HEA contracts can also underestimate the value of the home during the up-front payment. For instance, the contract could estimate your home’s value at $450,000 even though you’re likely to get $500,000 on the market, which effectively locks in a sizable payout for the issuer.
The complexity of these contracts can make it easier to miss these features. Unsuspecting homeowners who do not carefully review and negotiate the terms of these agreements could end up paying far more for a HEA than a traditional HELOC.
The bottom line
The market for home equity agreements is rapidly expanding, as more homeowners are drawn to the appeal of easy cash without interest rates or monthly payments. At first glance, these agreements might sound like a better deal than borrowing against the value of your property.
But the structure of these agreements can put homeowners at a disadvantage. When you run the numbers, you could discover that a HEA is more expensive over the long run than a traditional HELOC.
“Under many contracts,” notes CFPB (2), “the settlement amount grows at a rate of 19.5% to 22% per year in the early years, which is substantially higher than interest rates on most home-secured credit.”
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Article sources
We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
Federal Reserve Bank of St. Louis (1); Consumer Financial Protection Bureau (2)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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