By Peter Mastrantuono
Imagine accessing your home equity and not being required to make any monthly repayments or charged any interest. It’s possible through a shared appreciation (sometimes called a shared equity) agreement. But just because the funds come interest-free doesn’t mean they come without a cost.
How a Shared Appreciation Agreement Works
Unlike a conventional home equity loan on which a borrower will be required to pay interest and make monthly payments, a shared appreciation arrangement allows a homeowner to convert home equity into cash in exchange for transferring a portion of the home’s future price appreciation to the investment company that provided the funds. In a nutshell, this is not a loan; it is taking on an investment partner in the ownership of your home.
The amount of home equity a homeowner is able to access will depend on each company’s maximum loan-to-value and total maximum investment limits.
The repayment of funds is typically required after a ten-year period, though some shared appreciation providers offer a 30-year payback term.
When the time arrives to sell the house or the term has ended, homeowners are required to pay back the original amount advanced, plus some percentage (anywhere from 15% to 40%) of the appreciation that occurred between the date that the agreement was completed and the end of the term or when the house is sold. If the house has lost value, the funds owed will be reduced by amount dictated in the agreement.
Look Before You Leap
While the upfront cash with the absence of interest and monthly repayments is awfully enticing, there are a number of serious drawbacks to shared appreciation agreements that homeowners need to consider, including:
- Upfront administrative fees that may be up to 4% or higher of the home equity amount being accessed, which is deducted from the funds being advanced.
- The investment company providing the funds may discount the home’s fair market appraisal, which means that right from the start a homeowner may have already forfeited 15%-40% of the home value between its actual value and the discount applied to the appraisal.
- Homeowners need to consider how they will find the cash to pay back the principal amount plus any share of future appreciation owed to the investment company at the end of the term if they do sell their homes.
- Any appreciation due to home improvements may have to be shared with the investment company even though the homeowner paid for the full cost of the renovation.
Does a Shared Appreciation Agreement Make Sense?
For some individuals, entering into a shared appreciation agreement may make sense, especially if they are house rich and cash poor, have large debts or are unable to obtain a conventional home equity loan. A shared appreciation agreement can end up very likely costing far more than a conventional home equity line of credit, which may charge an interest rate of prime plus 3%-4%.
If you need guidance in determining the smartest way to access the equity in your home, you may want to speak with a financial advisor capable of evaluating the benefits and drawbacks to each available option and which one may make the most sense for you.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.