How Do Home Equity Agreements Work? Key Details to Know
Understand how home equity agreements work, including eligibility, repayment, and key financial considerations before accessing your home's equity.
Home equity agreements allow homeowners to access cash without taking on debt. Instead of borrowing, they receive funds in exchange for a share of their home’s future value. This option can be useful for those who don’t qualify for traditional loans or prefer to avoid monthly payments.
While it provides immediate liquidity, it comes with trade-offs. Understanding repayment terms, tax implications, and long-term costs is essential before committing.
Eligibility Requirements
Not all homeowners qualify for home equity agreements. Providers assess risk based on home equity, property type, location, and credit history.
Homeowners typically need at least 25% to 30% equity, meaning their mortgage balance must be significantly lower than the property’s market value. This ensures providers have a reasonable expectation of future appreciation.
Most agreements apply to single-family homes, townhouses, and some condominiums. Multi-unit properties, vacation homes, and investment properties may be excluded or subject to stricter terms. Location also matters, as providers focus on metropolitan areas with stable or appreciating markets. Homes in rural or declining areas may not qualify.
Credit history is reviewed but with more flexibility than traditional loans. A high credit score can improve terms, but homeowners with fair or poor credit may still qualify if they have significant equity. Recent bankruptcies, foreclosures, or major delinquencies can be disqualifying. In most cases, the homeowner must occupy the property as their primary residence.
Funding Amount and Terms
The amount homeowners receive depends on the property’s appraised value, existing equity, and provider risk assessment. Typically, providers offer 10% to 40% of the home’s market value. For example, a homeowner with a $500,000 property and 50% equity may receive between $50,000 and $200,000.
Unlike loans, home equity agreements have no fixed interest rates or monthly payments. Instead, providers receive a share of the home’s future value at sale or buyout. If the property appreciates significantly, the provider’s share increases, potentially making repayment much higher than the original amount. Some agreements cap returns to prevent excessive costs.
Terms typically range from 10 to 30 years, with most lasting 10 to 20 years. During this period, homeowners must maintain the property, pay property taxes, and keep insurance current. Some agreements allow early buyouts, though this often requires a new appraisal and may involve fees.
Calculation of Ownership Share
The provider’s share of the home’s future value is based on the appraised value and risk assessment. Instead of accruing interest, their return is tied to appreciation.
For example, if a provider offers $100,000 on a $500,000 home, they might take 25% to 40% of future appreciation. Some apply an appreciation multiplier, increasing their share. A 3x multiplier on a 10% equity stake would entitle the provider to 30% of appreciation rather than a direct 10% cut.
Some agreements include minimum return thresholds, meaning homeowners may owe a fixed percentage even if the home’s value doesn’t rise. If a homeowner buys out the provider’s stake before selling, the repurchase price is based on an updated appraisal. Some agreements also include a floor valuation, ensuring the provider recoups at least their original investment even if the market declines.
Repayment Structure
Homeowners do not make periodic payments. The agreement concludes when the homeowner sells, refinances, or reaches the contract’s expiration. At that point, an appraisal determines the provider’s share.
If the home has appreciated, the provider receives their agreed-upon percentage of the gain, which can increase repayment significantly. If the home has depreciated, the provider may still be entitled to a minimum return, depending on contract terms.
Some agreements allow early buyouts, requiring homeowners to repurchase the provider’s interest at fair market value. This process may involve appraisal fees, administrative charges, and potential penalties. Some providers impose time-based repayment adjustments, increasing their share if the homeowner exits within the first few years.
Property Sale or Refinance
A home equity agreement is typically settled when the homeowner sells or refinances. The provider’s share is calculated based on the home’s market value at that time. If the home has appreciated, the provider’s payout increases, reducing the homeowner’s net proceeds. Some agreements ensure a minimum return even if the home loses value.
Refinancing can also trigger repayment. Some providers allow refinancing without requiring settlement, while others mandate repayment if a new loan is taken out. If refinancing is permitted, the homeowner may need to maintain a minimum equity percentage or ensure the provider’s interest remains secured. A simultaneous refinance and buyout requires a new appraisal to determine the updated repayment amount.
Tax Factors
The tax implications of a home equity agreement depend on how the IRS classifies the transaction. Unlike a loan, the funds received are not considered debt, so they are not subject to interest deductions like a home equity loan or HELOC. However, because the provider is purchasing a share of the home’s future value, the transaction may be treated as a partial property sale, which could have capital gains tax consequences.
If the home appreciates and the provider receives a portion of the gain, the homeowner may owe capital gains taxes on their remaining share. The IRS allows homeowners to exclude up to $250,000 ($500,000 for married couples) of capital gains on a primary residence if they meet ownership and occupancy requirements. If the appreciation exceeds this threshold, the taxable portion could increase due to the provider’s stake.
If the homeowner repurchases the provider’s share before selling, the transaction may be treated as a capital investment rather than a sale, potentially altering the tax treatment. Consulting a tax professional can clarify the specific implications.