Understanding Home Equity Investments: Key Takeaways
- When a home equity investment (HEI) term comes to an end, homeowners face a crucial decision: determining the best way to settle the investor’s share of their home equity.
- Homeowners have several options to consider, including selling their home, refinancing their mortgage, or buying out the investor, each with its own set of advantages and disadvantages.
- The optimal choice depends on individual financial circumstances, long-term housing plans, and personal risk tolerance, making it essential to weigh the pros and cons of each option carefully.
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A home equity investment doesn’t have a traditional endpoint like a mortgage, where the loan is gradually paid off through amortization or a final payment. Instead, when an HEI term concludes, homeowners must navigate the process of settling the investor’s claim on their home’s equity.
This article provides an in-depth exploration of the options available to homeowners at the end of an HEI term, discussing the trade-offs associated with each choice to help inform decision-making.
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Insights from Experts in Home Equity Investments
Michael Gifford, CEO of Splitero
“Home equity investments tend to be most beneficial for homeowners who plan to stay in their homes for an extended period. While there are no prepayment penalties, it’s crucial for homeowners to carefully consider their long-term plans before entering into such an agreement.”
Navigating the End of a Home Equity Investment Term
A home equity investment provides an investor with a claim to a portion of a home’s future value in exchange for an upfront payment, with no monthly payments or traditional interest rates applying.
The investment is resolved when specific events occur, such as the sale of the home, the end of the agreed-upon term, or an early buyout of the investor’s share. At the conclusion of the term, homeowners must decide how to settle the investor’s equity stake, typically through one of three main paths.
Selling the Home: A Straightforward but Significant Decision
Selling the home is often the most straightforward way to resolve a home equity investment, as it converts the home into cash, allowing the investor to receive their share from the proceeds, with the remaining equity going to the homeowner. However, this simplicity comes with its own set of trade-offs, including the potential loss of a desired home and the impact of market conditions on the sale price.
The timing of the sale is critical, as it can significantly affect the amount of equity remaining after the investor is paid. Additional costs, such as agent commissions, closing fees, and moving expenses, can further reduce the net proceeds from the sale.
Refinancing: An Alternative to Selling
Refinancing offers another way to resolve a home equity investment by borrowing against the home to pay out the investor, replacing the shared appreciation obligation with traditional debt. This option allows homeowners to stay in their property and avoid selling but introduces a new set of risks and responsibilities.
Pitfalls of Refinancing an HEI
Refinancing often appeals to homeowners who value predictability and control over their financial situation. Once the investor is paid, all future appreciation of the home’s value belongs to the homeowner. However, qualifying for a refinance requires good credit, sufficient income, and an acceptable loan-to-value (LTV) ratio. In environments with higher interest rates, refinancing may be less attractive, even when home values are strong.
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Buying Out the Investor: Maintaining Control and Avoiding Debt
A buyout allows homeowners to keep their home and avoid taking on new debt by paying the investor directly based on the home’s current value and the agreed-upon share. This approach provides control, as there’s no sale, no lender, and no ongoing obligation tied to the home. However, it typically requires access to cash savings or proceeds from other asset sales.
The main advantage of buying out the investor is the maintenance of control and the avoidance of interest payments. However, tying up large amounts of liquid capital in a single asset can reduce financial flexibility, especially if unexpected expenses arise.
Common Mistakes to Avoid at the End of an HEI Term
Several common mistakes can make exiting a home equity investment more stressful than necessary:
Common Mistakes at the End of an HEI Term
The Bottom Line: Making Informed Decisions About Home Equity Investments
When a home equity investment term ends, homeowners face a critical decision: how to settle the HEI provider’s share of their home. Selling, refinancing, or buying out the investor are all viable options, each affecting cash flow, housing plans, and long-term flexibility in distinct ways.
Making this decision easier and less costly involves planning ahead, allowing time to compare outcomes, prepare for refinancing if necessary, and align the exit strategy with broader financial goals.
The best approach depends on how the homeowner plans to use their home and manage their equity going forward. For those ready to proceed, consulting with a lender today can be the first step towards a successful transition.
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
By refinancing an existing loan, the total finance charges incurred may be higher over the life of the loan.
