What is a Home Equity Agreement?

In the wake of high inflation, rising interest rates and a slowing economy, cost of living pressures are front of mind for many Australians. Financial stress can be powerfully disruptive, and in times like these even homeowners earning a good living can feel trapped by mounting mortgage repayments and other debt costs. 

Historically, homeowners haven’t had many options to leverage their home as a financial resource, but that is slowly starting to change. Rather than keeping wealth locked up in their properties, homeowners may want to examine the role of their home as an accessible source of capital and factor it into their long-term financial planning.

That's where home equity agreements (HEA) can help.

Home equity agreements provide a way to leverage the equity in your home to help you meet your financial goals. Whether you’re looking to get those long-awaited renovations done, pay off other debt, start a business or make a large purchase, a home equity agreement can be an attractive solution.

Keep reading to learn what a home equity agreement is, how it works and the pros and cons worth considering.

Home equity agreements explained

A home equity agreement, also known as home equity sharing, home equity sharing agreement, or home equity investment, is a financial arrangement between a property owner and an HEA provider. This agreement enables homeowners to unlock some of the equity they've accrued in their homes.

This arrangement diverges from home equity loans and lines of credit as it does not involve monthly debt or interest payments.

Instead, you can receive a lump-sum payment by agreeing to share a percentage of any increases in the home’s value over time. This means there are no monthly principal or interest repayments. Instead, the homeowner agrees to repay the received amount plus a predetermined share of the equity within a specific time frame or when the property sells. This is typically when you sell your home, refinance, or the agreement’s term ends. Similar to a traditional loan you will also be required to grant the HEA provider a security on your property. 

It’s important to note that during the term of the agreement homeowners will: 

• Continue to be liable for property taxes, general maintenance, and other typical expenses like property insurance.
• Have the ability to do renovations just like normal. Home equity agreements usually have some guidelines on how to account for any equity the renovations add to the property value, so it's important for homeowners to consider before undertaking any capital works. 

HEAs serve as an alternative to conventional borrowing options like home equity loans or mortgage refinancing. However, understanding the advantages and disadvantages of home equity sharing is crucial, as these arrangements have their unique pros and cons. Seeking advice from a financial or legal expert is recommended to ensure that an HEA matches your financial requirements and objectives.

An example of a Home Equity Agreement

To illustrate how a home equity agreement works, here's a typical example:

Let’s say your home has an appraised value of $500,000, and you enter into a contract with one of the HEA providers on the market. They agree to provide a lump sum of $50,000 in exchange for 20% of your home’s appreciation.

Then let's say you want to sell the home or buy back the share from the HEA provider  in 5 years time. 

• If you want to sell, the price you get will determine the agreed upon value to calculate the amount you owe the home equity provider. 
• If you want to repurchase the shared equity, an independent valuation would be completed to determine the value of the home instead. 

If the property increases in value by, say, $200,000 over the next 10 years, you would be responsible for repaying the initial $50,000, plus 20% of the $200,000 gain — or an extra $40,000. 
If the property value remains constant or goes down, typically the home equity provider would only recoup the original amount received. There may also be discharge or ancillary fees.

Benefits of home equity agreements

Engaging in a home equity agreement can yield several benefits for a homeowner, including:

Absence of monthly payments

HEAs, as opposed to traditional borrowing mechanisms like loans or mortgage refinancing, do not require monthly payments. This offers a clear benefit for homeowners with restricted cash flow or those not willing to shoulder additional debt.

Relaxed credit eligibility

HEAs typically have more flexible credit history prerequisites than conventional loans. This makes HEAs an appealing option for homeowners that might have limited access to more traditional finance options.

Flexibility in how you can use the funds

The capital derived from HEAs can usually be utilised freely, allowing homeowners to spend the funds on home upgrades, debt consolidation, or even leisure travel. However, it’s important to check the loan agreement for any restrictions.

Risks of home equity agreements

Despite its advantages, certain risks associated with home equity agreements must be considered before a homeowner relinquishes a share of their home equity. These include:

Implications of a lump sum payment

HEAs usually offer a lump sum payment which can be very tempting to spend. It’s critical for homeowners to ensure their spending aligns with their bigger financial goals and meets any conditions set out in the HEA contract. 

Importantly, homeowners should contemplate the extent of home equity being surrendered and ensure the accuracy of the home's appraised value. A low appraisal might result in the investment company receiving a more significant equity share than warranted, leading to substantial future costs for the homeowner.

Potential high costs based on home appreciation

The expenses associated with an HEA could be considerable, depending on the home's value appreciation. The HEA provider receives a share of your home's future value, meaning if your home appreciates, the initial cash payment plus a share in the appreciation must be repaid.

If the home's value remains stagnant, at a minimum you'll need to repay the drawn equity. Even though you can sell your home at any point, depending on the HEA provider, there may be discharge and ancillary fees.  This ultimately depends on your agreement with the HEA provider. It's crucial to thoroughly research and compare the pricing structures, including fees and policies, of various HEA providers before entering an agreement.

Wrapping up

A home equity agreement is an alternative to traditional methods of borrowing. There are no monthly payments or interest charges, typically more lenient credit requirements and additional flexibility on how you can use the funds.

It’s always important to consider the risks associated with any lending product but these types of solutions could provide an opportunity for more Australian homeowners to meet their financial goals. 

Please be aware that every HEA provider will have distinct and specific rules, terms, and conditions that govern their agreements so it is important to take the time to compare and contrast the offerings from different HEA providers to make an informed decision that aligns with your financial objectives.