Home equity agreements (HEA) or home equity investments (HEI) contracts have been gaining traction as an alternative to traditional HELOCs. But the finer print on these complex agreements reveals why their growing popularity could be putting many vulnerable homeowners at risk.
Understanding home equity agreements
As the name suggests, a HEA is a financial agreement that offers homeowners up-front cash in exchange for some of their home equity. The agreement usually involves a fixed term (such as 15 years) after which the homeowner must repay the up-front cash along with a multiple of their home’s value at the time of settlement.
Since this isn’t a typical loan, many homeowners are tempted by the appeal of receiving cash without a monthly interest payment or credit check. This could be why these contracts have become more popular in recent years, according to the Consumer Financial Protection Bureau (CFPB).
In the first ten months of 2024, 11,000 home equity contracts collectively worth an estimated $1.1 billion were signed. The total market is estimated to be somewhere between $2 and $3 billion (2).
Although this niche market is still considerably smaller than that for HELOCs, the CFPB expects it to continue growing for the foreseeable future. But the underlying complexity of these agreements could be exposing homeowners to more risk than they appreciate.
Multiple potential pitfalls
Although HEAs seem like simple equity-sharing agreements on the surface, digging deeper reveals just how favorable the terms are for the company issuing these contracts.
For starters, the up-front cash payment often involves a fee for the homeowner, often 3% to 5%, according to CFPB. That reduces the amount of cash you actually receive. Meanwhile, the contract often involves several features to protect the issuer from downside risks. For instance, the multiplier used to calculate settlement is often higher than the ratio of home equity the homeowner gets paid for.
For example, notes CFPB, a homeowner could sign an agreement to receive cash for 10% of their home’s equity but the contract applies a 2x multiplier, which means they must pay 20% of the home’s long-term appreciation (2). Not only is such an arrangement unfavorable for the homeowner, it also means the home would have to lose significant value before the issuer faces any losses.
