Americans have more value locked in their homes than ever. Now, a new breed of companies want to help them turn it into cash, but there are risks.
In the third quarter of 2020 the average mortgage holder had $200,000 worth of equity in their home, according to real estate data firm CoreLogic. That’s up $17,000 per household from a year earlier, the largest gain in six years.
With millions out of work and facing hardship due to the coronavirus pandemic, that home equity has served as a cushion against financial woes. Americans collectively withdrew $39 billion through cash-out refinances in the third quarter — a more than 25% jump from the same period a year earlier, according to Freddie Mac.
Other homeowners turned to an alternative sometimes called co-investing or home equity sharing. Co-investing startups such as Noah, Unison and Haus buy up to $550,000 in equity from homeowners, providing access to cash in exchange for a portion of future appreciation. It’s modeled in part on the way companies are financed — through a combination of debt and equity.
That means, instead of making monthly principal and interest payments like they would on most loans, homeowners typically pay back the investor in a lump sum, often when the home sells. If the value of the home goes up, the investor takes a big chunk of the profit. If it drops, both the homeowner and the co-investor take a loss. e.
Many of these companies, all based in California, have been around for a few years, but say the pandemic combined with soaring home values, have increased demand for co-investment. Lenders tightening mortgage requirements may be drawing more homeowners to co-investing products.
The companies declined to share detailed stats, but Noah saw a 100% increase in the funds homeowners requested in 2020, a company PR representative said. From 2018 to 2019, Unison reported a revenue increase of more than 200%. Since its start in 2014, the company has completed roughly 8,000 co-investments."
“It is a fintech solution to a mortgage market that is so plain vanilla otherwise,” said Tom Millon, CEO of Computershare Loan Services, a mortgage service provider.
How do I qualify?
Each co-investor has its own qualification thresholds, investment principles and repayment terms.
“Noah is not a debt solution,” said Sahil Gupta, founder of the firm. “We look at the home as an asset, the equity homeowners have and their financial profile.”
Noah requires a credit score of at least 600 points, which is lower than what lenders typically seek for mortgage cash-out refinances and home equity lines of credit, or HELOCs. Banks usually require at least 680. But so does Unison.
Co-investors also consider how debt-burdened borrowers are. Unison doles out cash to homeowners whose mortgage has a loan-to-value ratio of up to 75%. Haus and Noah, meanwhile, will go up to 90% LTV.
What types of homes will they invest in?
Unison, Noah and Haus invest in single-family homes and condominiums that are typical for the local market. This allows co-investors to easily appraise the residences they buy into.
“If your neighborhood has mostly houses that have three or four bedrooms, and you have a 20-bedroom chateau, we cannot work with you because we don't really know what it's worth,” said Thomas Sponholtz, founder of Unison. “It just has to be not an abnormal house.”
While they prioritize primary residences, some equity-sharing firms also consider rental properties and second homes.
Who is co-investing right for?
Co-investing is available to individuals who have already built a sizable amount of home equity. For those homeowners, co-investors can unlock funds that can be used in multiple ways, including retirement planning, said Sponholtz.
“You can use [the cash] to secure your retirement by buying investments that maybe produce income once you do retire or just to pay living expenses,” he said.
During the pandemic, Unison has also seen interest from homeowners seeking money to make home improvements. Unison’s policy is that any value created through property upgrades, assessed with a post-renovation appraisal, belongs to the homeowner.
Jonathan McNulty, CEO of Haus, said co-investing can also be an attractive option for millennials unwilling to carry a lot of debt. With an average outstanding student loan balance between $20,000 and $25,000 in 2018, according to the Federal Reserve, this generation is already financially burdened.
As co-investing startups plan to expand into down-payment assistance, equity sharing may become an even more appealing option for some first-time home shoppers.
The cost of co-investing
Most firms charge 3% to 5% transaction fees for new co-investments, which last up to 10 years with Noah and Haus and can stretch for 30 years with Unison. A partnership with Noah or Unison also does not carry any monthly repayments, as the companies recoup any gains – or incur losses – at the end of the equity-sharing term or at the time of sale.
For example, based on a free calculator on Unison’s website, a qualified owner of a $700,000 house can receive up to $122,500, which is the maximum 17.5% of the home value Unison can purchase. For that, Unison will get 70% of the change in value in the future. That means, for every $100,000 increase in values Unison will pocket $70,000, in addition to the repayment of the original investment.
On the other hand, if the home value instead drops by $100,000, Unison would lose $70,000 on its initial investment, meaning that the homeowner will repay the company $52,500. With a traditional mortgage, even if the value of the home drops below the outstanding loan balance, the homeowner will have to pay back the loan in full.
The disadvantages of co-investing
While it allows quick access to liquidity, some experts warn that co-investing can bear long-term implications for building wealth.
Lee Hamway, with FM Home Loans in New York City, cautions that over the long run equity sharing can prove pricey. “At the end of the day, it does get a little bit expensive,” he said. “You just pay significantly on the backside of it.”
Similar to a HELOC, a co-investment is typically considered a second lien, which means in the event of a foreclosure it is repaid after the primary mortgage. However, in a home sale, if the proceeds do not cover both the outstanding mortgage and the amount owed to the co-investing partner, the homeowner may have to make up the difference out of pocket.
“A cash constrained homeowner could find themselves in a difficult position if you're 10 years down the road or at a specific point in time and [you] actually have to buy that equity back,” said Sam Chandan, associate dean for the Schack Institute of Real Estate at New York University. “To buy the equity back you may have to take out a more traditional home loan or a home equity line of credit to finance out of your position.”