Should You Tap Your Home Equity with Equity Sharing?

Many Americans own a home and have equity locked in it. To be precise Americans own nearly $20 trillion worth of home equity, and of that amount $6.6 trillion is tappable. Before talking about the options available to cash out on this equity it is important to define what tappable means.

Avoid Private Mortgage Insurance 

In the home finance space lenders will allow homebuyers and homeowners to borrow up to 97% of the value of their home. So by definition, most homeowners own a minimum of 3% of their home. But borrowing more than 80% of the value of a home requires the purchase of private mortgage insurance (PMI) which insures the lender against default. The reason for this is because the evidence seems to show that when a homeowner owns less than 20% of their home they are more likely to default because they have less skin in the game.

Cash-out Refinance or HELOC

Given this, tappeble home equity is defined as any equity owned by homeowners that is greater than 20% of the value of the home. In aggregate homeowners in the US own $6.6 trillion of this type of home equity. Mostly this home equity is an untradable asset that is locked up in a home and can only be turned into cash upon a sale. Now of course, if the homeowner has good credit and income they can borrow against their equity by doing a cash-out refinance or taking out a home equity loan or line of credit. In this case, home equity is used as security for a loan. This means that the entire amount needs to be repaid with interest and payments need to be made regularly. 

Housing Partnerships and Equity Sharing Programs

Over the last couple of decades, however, another method of liquidating home equity has emerged. It is called equity sharing programs. Many of these programs were inspired by the 1997 book entitled “Housing Partnerships: A New Approach to a Market at a Crossroads” by Andrew Caplin, Sewin Chan, Charles Freeman, and Joseph Tracy. What the book proposed is simple: allow the homeowner to sell part of their home equity to an outside institutional investor (a bank or an investment company). In return for the equity stake, the homeowner would get cash. Upon the sale of the home, the institutional investor would be entitled to the proceeds that are equal to the percentage of equity they purchased.  

No Monthly Payments

There are a few companies that have tried to implement versions of this shared equity model. They all offer cash in return for an equity interest in the homeowner’s home. Also, they do not require any monthly payments. In that sense, they are the same as described in the book mentioned above. But there are also some key differences in the following categories. 1. Term of investment. 2. Cost to the homeowner.

Risk of Current Equity Sharing Programs

Let’s start by talking about the term of the investment. All of the companies that offer cash in return for an equity interest do so for a limited term of between 10 and 30 years. This means that the homeowner is obligated to somehow pay the investor their equity interest in the home at the end of the term. To allow for this homeowner must either take out a new loan against the home or sell their home. If they do not the investment partner can force the sale of the home, this could potentially leave the homeowner homeless. 

No Monthly Payments but High Cost to Homeowner

With regards to the cost to the homeowner, it would seem fair that if the investor bought an equity stake in the home they should get a return on that equity stake. If the home appreciated in value they get a return that is greater than the original investment but in proportion to that investment. In reality, however, these companies invest in the home and demand a return that is disproportionally greater than their original investment. 

Outsized Returns to Institutional Investor 

Taken together -- the limited term of investment and the outsized and disproportionate returns demanded -- it makes the shared equity program offered by these companies untenable for the average homeowner in terms of cost of capital and risk to their home. Two things are clear to me, first that there is huge potential in the shared equity program, and second that for it to truly scale the pricepoint and the terms need to be more favorable to the homeowner. Inexpensive Equity Sharing Program on Homeowner's Terms

Invown was founded to do just that. With our product homeowners will be able to sell their home equity to investors on, not the bank’s, but their terms, which would potentially include an unlimited investment timeframe as well as an equitable split of any home appreciation. Get in touch with us if you would like to be an early adopter or if you simply would like to learn more.