As a mortgage professional, you’re likely used to helping clients who seek ways to pay for everything from home renovations and medical bills to college tuition and credit card debt. Using their home equity can be appealing, especially when home values are rising and interest rates are low.
While home values will likely continue to increase, consumer spending power is decreasing in the face of inflation and higher interest rates. In response to inflation, Federal Reserve rate hikes have previously meant higher mortgage rates, in turn making home equity financing options more expensive.
“Home equity investments aren’t as well known, but they can be an innovative choice for clients who don’t want to or can’t afford to take on debt to access their equity.”
These circumstances mean that your clients might need to spend a bit more time figuring out the best choice for themselves. Historically, the most popular forms of equity-based financing are home equity loans, home equity lines of credit (HELOCs) and cash-out refinances.
A newer and less well-known product, the home equity investment, has also emerged as a viable option. Before diving deeper into the details of home equity investments, let’s review the traditional equity-based lending solutions. In terms of the general economic climate and your client’s financial profile, there are advantages and disadvantages to consider for each option.
Traditional products
With home equity loans, which feature fixed interest rates, homeowners can receive a lump sum of cash to pay for home renovations or repairs, or to pay off other bills. To qualify for these loans, homeowners need sufficient income, a good credit score and 2% to 5% of the loan amount for closing costs.
Home equity lines of credit allow homeowners to pull from an approved amount of equity as needed. Like home equity loans, HELOCs require good credit and have minimum income requirements. But they come with variable interest rates, meaning that monthly payments can fluctuate. And if the borrower’s home value decreases, the lender can freeze the HELOC.
As of March 2023, interest rates for home equity loans and HELOCs range from 6% to 10%, and they may increase further if federal rate hikes continue. In both cases, the home is used as collateral, so the loan balance is repaid via monthly installments.
With a cash-out refinance, homeowners replace their original mortgage with one for a larger amount and pocket the difference to pay for expenses. Although interest rates for cash-out refis are typically lower compared to home equity loans or HELOCs, the closing costs can be more expensive.
Home equity investments
Home equity investments aren’t as well known, but they can be an innovative choice for clients who don’t want to or can’t afford to take on debt to access their equity. With this option, homeowners receive cash upfront in exchange for a share of their home’s future value.
Qualification requirements are often less stringent than with traditional financing choices. And there aren’t any monthly payments or accrued interest — just an appraisal fee, an origination fee and other closing costs. There’s also no income verification, which can make this an appealing option for self-employed workers and those without customary W-2 income.
The term lasts anywhere from 10 to 30 years. The homeowner can buy out the investment at any time with savings, by refinancing or through the proceeds of a home sale. Home equity investments can be more expensive than traditional types of products, however, with the investor receiving their initial payout plus a significant percentage of any future increase in home value (often 25% or more).
Like traditional equity products, home equity investments don’t come with any restrictions. Some homeowners put the money toward starting or expanding a business, paying down debt, covering a child’s education or diversifying their portfolio. And there are plenty of other ways for homeowners to use the proceeds from a home equity investment.
- Second homes. Home equity investments can cover the downpayment and closing costs for a vacation home.
- Home renovations. Home equity investments can pay for renovations or repairs that boost a home’s value prior to sale.
- Bridge loan alternative. Bridge loans give borrowers fast cash so they can buy another home before selling their current property, but they come with high interest rates and fees. While a home equity investment can take as little as a few weeks to close — longer than the bridge loan timeline of a few days — it can be a smart alternative for people looking to buy their next home.
- Real estate investing. Investment properties can present great opportunities for portfolio diversification and passive income, but the downpayments, closing costs, and ongoing expenses such as insurance and repairs can add up. Home equity investments can help cover the expenses needed to get started.
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Mortgage originators who add home equity investments to their portfolio of solutions can help themselves and their clients in a number of ways. Not only can it help you distinguish yourself by providing an innovative product that most financial institutions don’t offer, it can also allow clients to pay off debts, enjoy more financial freedom and build future homeownership opportunities.
Since the home equity investment model is still relatively unknown, introducing homeowners to this option increases awareness and education of the product while enabling them to make informed decisions about the many equity-based financing solutions. Traditional equity loan options have become less accessible and less ideal in today’s higher inflation and higher interest rate climate. With home equity investments, your clients can still benefit from tapping into their equity without the stress of monthly payments or upfront debt. ●
