Kenneth Harney
With homeowners’ equity soaring to near-record levels, financial technology entrepreneurs – backed by deep-pocket venture capital – are dreaming up sophisticated ways to help consumers access that equity without traditional interest payments.
The core concept in most of these plans: We’ll give you cash, say $30,000 to $200,000 or more, if you’ll let us share in some of the growth in value of your home when you sell, refinance or buy us out. And we’ll share some of the downside if home prices go south. You can do whatever you want with the money – pay off high-cost credit card debt, invest in a business, whatever.
The idea of cutting investors into a slice of future equity growth is not new; in the 1980s it surfaced in the form of the “shared appreciation mortgage,” or SAM, which offered lower interest rates in exchange for a piece of the appreciation action. During the housing bust years, when virtually nobody had appreciation to share and equity holdings tanked, the idea fizzled.
But now appreciation is back big-time – the Federal Reserve reported Sept. 16 that American homeowners have $12.7 trillion in equity, double what they had as recently as 2011.
The newest tech-driven equity-tapping products are not loans. They are essentially option investment contracts secured by your house giving third parties a piece of your appreciated equity. They use big data and algorithms to custom-tailor offers of immediate cash in exchange for a slice of your future gains. They can be attractive but they can also be expensive. You need to pay close attention to all the moving parts.
Not Cheap Money
Take this example provided by Point Digital Finance Inc. The company’s equity-access program is currently offered in California and Washington state and scheduled to be introduced to East Coast markets – Washington D.C., Maryland, Virginia, New York – before the end of this year. Next it will move into the Midwest and elsewhere, according to Eddie Lim, CEO and cofounder.
Say your house appraises at $630,000. Assuming that you and your property pass Point’s underwriting tests, Point might agree to give you $72,000 in exchange for just under 33 percent of future appreciation. Ten years later you decide to sell the house, which is now worth $900,000. Out of the sale proceeds Point would expect its original $72,000 back plus $120,070.67 of appreciated value. You’d retain $707,923.33, part of which would be the remaining mortgage debt you’re carrying.
Sound like a good deal? It might be if you urgently needed the cash, couldn’t qualify for or didn’t want to make interest payments on a home equity loan or credit line. But no way is it cheap money. Point calculates the “implied interest rate” on this transaction at 9.85 percent, well above bank loan rates. Bear in mind, though, that the cost might have been lower if your house appreciated more slowly or declined in value – both of which are always possibilities.
But look a little closer at the Point plan and you begin to notice details that you might find troublesome. There are fees up front – 3 percent of your cash comes off the top and goes to “processing.” Plus you pay for appraisals. Then there’s the upfront “risk adjustment” factor that is applied to the initial appraisal. In the case of the $630,000 house above, the adjustment downward is 15 percent, reducing your home value for the purposes of Point’s computation of appreciation to $535,500. The adjustment has the effect in the example of increasing the payout to Point’s investors significantly. It also protects them in the event of property depreciation; Point doesn’t start sharing in your losses until the home value drops below the “risk-adjusted” $535,000.
CEO Lim told me in an interview the adjustment is designed to “buffer against appraisal risk.”
Besides Point, there are two other current competitors in the equity-access space, each with their own approaches: Patch Homes, now at the beta intro stage but with plans to be a national player soon, and FirstREX, which operates in New York, D.C., Maryland, Virginia, Massachusetts, Washington and Oregon, and is now offering appreciation sharing on down payments for home buyers. They will give you part of the down payment cash you need in exchange for a share of future gains in value.
Check them out. But consult a financial adviser about the pros and cons of selling your future appreciation for immediate cash before you do so.
