Home Equity Agreement (HEA) – How It Works & Pros and Cons
Recently, many homeowners have explored a new way of getting cash; in return, they tap the equity of the house. Rising property values and fluctuating economic conditions influence financial conditions. Traditionally, homeowners have options like Home Equity Lines of Credit (HELOCs) and home equity loans. However, the property market evolves day by day and comes up with better options that reduce the burden of homeowners in many cases. Furthermore, in this article, Proptino.co.uk offers you the opportunity to explore what a home equity agreement is, how it works, and when you should apply for it. Moreover, what are the terms and conditions of HEA?
What is a Home Equity Agreement (HEA)
A home equity agreement is also known as an equity contract or shared equity agreement. This is a financial exchange in which homeowners get a lump sum and share their house's future appreciation or depreciation. In the future, after the mentioned time period, it may be 20-30 years in most cases. The homeowner sells it out and shares the mentioned equity in the contract 20% in most cases with investors.
This is one of the most liked methods which people use, as compared to getting the loan and paying the installment of every month. In this, you don't need to pay monthly. In HEA, the owner is sharing the equity of his/her house. This seems so convenient that in 2024, the U.S around $2 billion and $3 billion are having home equity agreements.
Read this article;
https://www.proptino.co.uk/en/226/what_document_do_you_need_to_selling_a_house_in_the_uk
Let's have a scenario that you can understand more easily.
Suppose a house whose current value is $350,000, the owner wants funds of $80,000. The investor gives him/her investment on the basis of 20% equity in the future appreciation for 15 years. At a specific time, the owner's house worth is $500,000 (this will be predicted by the investor and homeowner). He/she will give the original upfront $80,000 along with appreciation value, which will be $30,000 (20% of the $150,000 appreciation). Combining both upfront and appreciation, the owner owes $110,000.
Read this article; How To Get A House Valuation Without Selling Online?
How does a Home Equity Agreement work?
There is the proper step to step guidance which is followed by both the homeowner and investor. Here are the steps which help you to know further about it.
Initial Assessment
Well, the Home Equity Agreement starts through the buyer, who is searching for an investor to support the finance.
Here is the misconception about HEA, that you only raise the funds for home related works. In fact, you can use it for any purpose. Such as buying a new car, education, paying the previous mortgage or anything else.
When the borrower finds out the best investor. he /she will pitch out to him/her for the investment.
The investor also did some research on the property valuation, its location and predicted chances of getting benefits in future.Normally, the houses whose current valuation falls in- between $300,000 to $700,000, are more likely to get the funds.
Agreement Terms
Then, the agreement was signed out between the equity investor and homeowner. This can depend on the particular time duration 10-30 years. After mentioned time in the agreement the homeowner will sell the house and pay the upfront value with appreciation or depreciation. The amount of appreciation is predetermined into the agreement. In case of depreciation, the homeowners do not owe more than the original upfront value.
Investor Provides Lump Sum
Instead of providing the funds into the installment just like HELOC, the investor gives the funds into the lump sum upfront. And in return get the upfront along with appreciation or depreciation in future.
Homeownership Continues
After this, the home owner continued to live there without any interruption from the investor side. Until the time period which noted into the agreement.
Repayment to Investor
After the specific time period, the homeowner will sell out the property and pay the upfront money to the investor. After this, the agreement is completed and there will be nothing remaining between both of them.
Also read this article: Property for Sale or Auction? A Complete Guide to Making the Right Choice
When Should You Consider a Home Equity Agreement?
You can consider the home equity agreement when you need the funds, but you don't want to get into the trap of paying the installment for many years. Moreover, many people choose this option because they want to avoid debt in the future. Many others do not pass the criteria of traditional loan criteria, which started from a minimum of 620 - 700+. So, they decided to take a Home Equity Agreement (HEA) loan to meet their needs. Which only needs a 620 credit score.
Risks and Drawbacks of Home Equity Agreements
There is no doubt in it that Home Equity Agreement helps the owner to choose the ease and spend their life without any worries. But there are some drawbacks which make it questionable to get or not.
Uncertainty of future returns
There is uncertainty in the case of returning the funds along with upfront value, the appreciation value is also crucial. Maybe this is decided according to the original values of the house, or funds are decided according to the appreciated value of the house.
Here is an example
Suppose the home's original price is $40,000, and with the 10% of equity, you owe 10% of $40,000. When the equity price is decided based on the values of the original house,
The second scenario is that the home's original price is $40,000. When you take the HEA, but after 10-20 years, the price appreciates to $60,000. If the equity decided on the appreciated value of the house, then you need to pay 10% of $60,000
Loss of full property equity
Once you get the funds from investors and give the equity of your property. That means, you lost the full ownership of your house. Sometimes, this may be considered as a drawback because we have to share the selling price if you sell it or rebuy the house.
Read this article also; How to Sell A Shared Ownership Property
Lump-Sum Payment Obligation
Owner gets the payment in lump sum and retires after some years. He /she also has to give back the upfront with a dues. Like if your property is appreciated. There is still unpredictable how much the investor gets at the end.
Home Equity Agreement vs. Other Financing Options
Home Equity Agreement HEA is not the only loan taking a path. In fact, there are other procedures also. Here are the pros and cons of them, which help you to figure out which loan is best for you.
Home Equity Agreement (HEA)
In this the homeowner receives the lump sum and in return he/she gives the 20% equity in appreciation and depreciation of the house selling in the future.
Pros
There is no need to worry about the monthly payout.
Having no high criteria for getting the loan.
There is no interest on the loan.
Get the funds at once.
Cons
We need to pay a high amount at the end.
The appreciation is uncertain.
Lost the full authority of the house.
Home Equity Loan
A home equity loan is the second mortgage through which you can borrow a lump sum of money against the equity of your home. Its duration is 15- 30 years.
Pros
Possibility of tax reduction according to the purpose of the loan.
Can borrow money at a low interest rate.
Fixed interest rate.
Cons
Taking a loan against the property will be risky in the manner of reducing home value.
Need to pay on a monthly basis.
Your property will be collateral
Home Equity Line of Credit (HELOC)
HELOC works like a credit card, you borrow money and repay it. And this happened under the draw period. One more thing; as the HELOC is a secure way of loan. It also has the equity in your property.
Pros
Get funds on lower interest.
Having a long time (mostly 5 years) for a payoff
Flexibility on borrowing and repaying.
Cons
Your house will be collateral.
Variable interest rate
Owe more money to pay if the property's worth decreases.
Traditional Mortgage
A traditional mortgage is the loan which a person takes for the specific time duration 15-30 years on the basis of fixed or adjustable interest rates.
Pros
Getting a large amount at once.
Interest rates can be lower on personal loans
Fixed interest can be predictable.
Cons
A 20% down payment is required to get the mortgage.
Monthly paying the installment of the mortgage can be tough.
In case you do not pay, your house will be foreclosed.
What are the Eligibility Criteria for the Home Equity Agreement (HEA)
The Home Equity Agreement also has some eligibility criteria, and owners only get the funds if they stand out in these factors.
A person should have the ownership of the house.
You are only eligible for the property if you have significant equity (15-30%) in the home.
Property value: your property should be in good condition and contain a good market value. The location of the property also matters.
The applicant should have a stable job, Just to make sure that you are able to face any financial situation at the end of the contract.
Having a 620 credit score is enough to get the loan.
Tax Implication on Home Equity Agreement
There is no significant application for HEA funds. This is non-taxable. But when you sell the home to pay the equity of the investment in that scenario, you have to pay the selling tax of your home. Also, there is no interest in the Home Equity Agreement, as you are sharing the equity of your property with investors.
Also read this article; Do you pay tax on selling property in the UK?
Future of Home Equity Agreement
As this way of taking loans is becoming so popular, we can see a great spectrum of it rising in the future. Now, owners are using this method because of its functionality. These are;
Increased Popularity
Now, because of the flexible functionality of the HEA, many homeowners are taking this loan to spend their debt-free lives.
Broader Adoption
In the businesses, starting a startup is now common. People usually find HEA friendly. In case of when they are already burdened to make their business successful.
Customization
In the future, there is the possibility of customization of HEA. which makes it more affordable for homeowners.
Alternative Financing
As compared to traditional method of taking loan, HEA's become more comfortable. Because now, people mostly work online and they have flexible incoming methods, though handling the monthly payment is a bit tough for them.
Greater Understanding
Now, homeowners have the great exploration of different loan methods and from all of them, they find out the HEA's the right one.
Conclusion
The Home Equity Agreement is a new method of solving financial problems without getting indulged in it. It gives the homeowner a chance to be debt-free and live peacefully without thinking about paying the monthly installment as that happened into the mortgage. Moreover, this loan method also has drawbacks, which make it non-approachable for many owners. But maybe in the future, HEAs will evolve and come with new outcomes.
Source links
https://www.consumerfinance.gov/data-research/research-reports/issue-spotlight-home-equity-contracts-market-overview/
https://www.irs.gov/taxtopics/tc701
https://www.unison.com/home-equity-agreement%5C
Frequently Ask Questions (faq's)
How do we calculate the owed value of HEA?
A percentage of your home's value will determine the total debt during either time of sale or agreement conclusion. The future value is established at the conclusion of the agreement during the time of sales or home refinancing.
What would happen if I ended the agreement?
During HEA termination or home sale or refinancing you repay the provider according to the defined future home value percentage.
Do I need to have a good credit score for HEA?
Typically, no. A home equity agreement does not assess your credit score, so homeowners who have imperfect credit still have access to this financing option based on their home value.
Can I get the HEA if I already have the mortgage remaining?
People owning homes with current mortgages remain eligible to receive funds from an HEA program. The HEA provider considers the present mortgage balance during their assessment as homeowners can still extract a portion of their home equity through the agreement.
