One key way HEAs differ from traditional home equity loans is that homeowners give up a percentage of future home appreciation.

If you’ve seen ads promoting HEAs (home equity agreements) as a way to access home equity, they may sound like traditional home equity loans without monthly payments, but they’re not the same. With HEAs, a significant trade-off is that homeowners pay a percentage of their home’s future appreciation when they settle an HEA obligation. Here’s an overview of how HEAs work and how they differ from home equity loans and HELOCs.

How HEAs work

An HEA is a shared equity agreement where a non-bank company that specializes in home equity investments provides a homeowner with cash in exchange for fees to originate the transaction, as well as a percentage of the home’s future appreciation or value. The amount of cash made available depends on the homeowner’s equity. There are no income requirements, and credit score requirements are lower than those for traditional home equity loans issued by credit unions and banks. HEA contracts often last 10 years, but they may go up to 30 years.

Until the obligation is settled, the HEA company places a lien on the property securing its interest.

While the HEA company has equity in the home, they do not contribute to ongoing homeownership expenses. A homeowner with an HEA pays the full costs associated with home ownership, including mortgage, homeowners’ insurance, taxes and HOA dues.

How much an HEA costs

HEAs have upfront costs and costs that are due when the agreement is settled at the end of the contract term.

Upfront costs include an origination fee and third-party expenses for services like an appraisal, title search and filing fees. While origination fees vary by HEA provider, at the time of this writing, one HEA provider advertised a fee of 4.9% of the amount of cash the homeowner receives.

When the HEA expires, a lump-sum payment must be made. How much is due depends on the home’s appreciation and the formula used by the HEA provider. As a general rule, the stronger the housing market, the higher the settlement amount.

What’s in the HEA fine print

More costs and restrictions are often detailed in the HEA contract.

As investors, HEA companies want assurance that they’ll be repaid. While they advertise that homeowners may use the cash any way they want, homeowners may be required to pay off some existing debt first. For example, one HEA provider requires HEA proceeds to be used to clear any pre-existing liens other than a primary mortgage as a condition of the agreement.

Another built-in protection for HEA companies is a minimum payment provision that establishes a floor to help ensure their principal is returned. Value adjustment terms in the contract typically mean that even when a home depreciates due to market conditions or neglect, there’s a set amount that must be repaid at the end of the contract term.

On the other hand, if a homeowner makes improvements that increase the home’s value, the HEA provider may receive part of the value when the agreement is settled. An HEA contract with provisions that preserve homeowner equity increases from capital investments will require documentation like pre- and post-renovation appraisals, receipts and permits.

Another fine-print detail in many HEA contracts is that homeowners may be restricted from renting their house out. If a contract does allow a switch from owner-occupied to rental, the homeowner will owe additional fees.

How an HEA is settled

At the end of the agreement, or earlier if the home is sold or refinanced, the HEA provider is paid according to the contract terms. The homeowner either pays the HEA provider in cash or sells the home and uses a portion of the proceeds to settle the agreement. The home’s value at the time of settlement determines the final amount due. If the home has appreciated, the provider’s share will be higher than if the home value remained the same or went down.

It’s also possible for a homeowner to buy out the HEA company’s interest in the home before the contract term expires. The amount needed to settle the HEA depends on the contract terms.

If a homeowner dies while the HEA agreement is in effect, heirs are required to either buy out the HEA provider’s interest in cash or sell the house to obtain funds to pay off the HEA obligation.

Advantages of traditional home equity loans and HELOCs

There are three key advantages of traditional home equity loans and HELOCs such as those offered by Consumers. First, while homeowners make monthly payments, costs are more predictable. Second, homeowners keep full ownership of their home’s appreciation. Finally, in most cases, the total cost of home equity loans and HELOCs is lower than HEA financing.

 

 All loans subject to approval. Rates, terms, and conditions are subject to change may vary based on credit worthiness, qualifications and collateral conditions.