This piece originally appeared in the May 2024 edition of MortgagePoint magazine, online now.
FDR once called a home “the safest investment in the world.” And while this theory has been challenged from time to time, over the long-term, it has generally remained true.
The problem? It is not always easy for homeowners to use their home as an investment—especially those who are struggling financially. While home equity lines and HELOCs are commonly used for emergency expenses and debt consolidation, these products still require homeowners to meet certain lending criteria—plus they increase a homeowner’s overall debt.
Enter the housing market’s latest star–home equity investment (HEI) products. Available in different shapes and sizes, HEIs allow homeowners to access the equity in their properties without having to take on another loan. But for these products to realize their full potential, it’s going to take the expertise and resources of multiple industry stakeholders.
Why the surge?
An HEI, often referred to as equity sharing, is a financial arrangement in which a homeowner can access the equity in their homes in exchange for a portion of their home’s future appreciation. Instead of borrowing against their home and incurring more debt, a homeowner receives a lump-sum payment upfront, and the settlement occurs when the home is sold or the agreement term ends, and the best part … there are no monthly payments.
The market for HEIs is experiencing remarkable growth, reflecting a shift in how homeowners, originators, and investors view and utilize property equity. According to some estimates, the HEI market is believed to be around $2 to $3 billion annually, with the industry’s first HEI securitization last year paving the way for future growth.
The growing popularity of HEIs can be attributed to several factors. First, it is a debt-free solution to access home equity, which is particularly appealing in an inflationary climate where many homeowners are looking to minimize their financial burdens. This aspect is especially attractive to current homeowners who may have a less than ideal credit score, and want to avoid the monthly payments that come with traditional financing.
The simplicity and accessibility of HEIs are factors as well. By bypassing the traditional loan criteria, homeowners find that HEIs are a much faster, straightforward path to leveraging their most significant asset—their home. Recent fintech innovations have also made HEIs more accessible and user-friendly, thereby broadening their appeal.
However, current economic and housing market trends are probably the biggest factors behind the growth of HEIs. While high interest rates have slowed the housing market, home prices are expected to continue growing this year due to a shortage of housing inventory, and an increase in all-cash buyers and Wall Street investment firms. CoreLogic recently forecasted a 3% rise in home prices by October.
Market dynamics driving adoption
If rates happen to fall this year, as most economists believe they will, home prices may increase even higher, and rising home values will only further fuel the climb of HEIs. One of the biggest factors for HEIs is that many homeowners are already sitting on significant home equity, even those who purchased homes just several years ago. In fact, according to economic research by the St. Louis Fed, between a five-year period from the fourth quarter of 2018 to the fourth quarter of 2023, the median U.S. home price rose from $322,800 to $417,700, a 29% increase—and a median home equity gain of $94,900.
In March of this year, the National Association of Realtors (NAR) reported median home prices have continued to increase, up more than 5% in February 2024, compared to the previous year.
Along with rising home prices, however, mortgage rates are also up from the record lows at 2.5%-3% in 2020, to around 7% as of April of this year. For the vast majority of homeowners, this recent spike in rates has made traditional home equity loans, or even HELOCs, far less appealing. Yet another factor is that many recent homebuyers could use the financial help. In addition to the increased cost of household goods and services, most homeowners are experiencing insurance premium hikes due to an increase in natural disasters and severe weather events. In addition, more consumers have been leaning on credit for basic household expenses, one reason why total U.S. household debt grew to reach a record $228 billion in the third quarter of 2023, according to The Federal Reserve Bank of New York. Meanwhile, student loan debt forgiveness expired last October. These financial pressures are likely reasons why the delinquency rate on FHA (Federal Housing Administration) loans rose 131 basis points between the third and fourth quarters of 2023.
A recent Redfin-commissioned survey illustrated just how dire the scenario is for some homeowners. The survey found that roughly half of all homeowners and renters were struggling to make their housing payments, and among those struggling, one in five have skipped meals or taken on extra work to make ends meet. Many were also skipping vacations, selling their belongings, and even dipping into their retirement accounts to make their monthly payments. Housing costs have become so difficult, said Redfin Economics Research Lead Chen Zhao regarding the survey’s results, “that some families can no longer afford other essentials, including food and medical care.”
Given this scenario, it is likely even more homeowners this year will shy away from incurring additional debt through home equity loans and HELOCs and instead choose to receive cash today through HEIs—and pay it back at a future date. Of course, HEIs have their disadvantages, too, depending on how you look at them.
For one, most shared equity providers only provide cash for up to one-third of the homeowner’s equity, whereas a home equity loan may enable a homeowner to use up to 80% of their equity. Also, while homeowners receive immediate cash, they do have to share the appreciation of their property with an investor. So, if the property value increases significantly, they may have to part with a larger portion of their equity when they sell.
Another challenge is that there are all kinds of HEIs, each with different structures and terms, so it can be difficult to compare options or fully understand their long-term impacts. Additionally, while HEIs are not typically considered loans, some states have amended their statutes to regulate HEIs similar to mortgages.
The role subservicers play
Despite these drawbacks, the growing popularity of HEIs is likely to continue. For many, they are just too convenient of an option to access home equity with minimal hassle. And yet, for the HEI market to mature, it will require the involvement of other industry partners.
In most respects, HEIs are completely different than loans. But even though they do not involve loans or monthly payments, they still need to be serviced. Rather than handling payments and escrow accounts, servicers that manage HEI assets typically focus on property valuation, lien monitoring, investor relations, homeowner education, and bond rating agencies—which is why specialized subservicing plays such a critical role.
For instance, a question that a homeowner may ask about their HEI is quite a different conversation than a homeowner inquiring about their escrow balance.
A quality HEI subservicer must also be adept at monitoring property values regularly, as the evolving worth of the asset—the home—directly impacts both the homeowner’s and the investor’s eventual outcomes. Typically, this requires the ability to constantly track property values using advanced tools and analytics.
Automated lien monitoring is another critical aspect. Given the subordinated nature of HEIs, it is essential for subservicers to track all liens that could supersede the investor’s position. Ideally, this involves sophisticated technology capable of real-time lien monitoring and alerts, which ensure the investor’s interest is safeguarded.
Transparency and communication are key in HEI servicing as well. Investors need to have continuous access to information about their assets. A subservicer that offers a transparent, 24/7 portal can greatly enhance the confidence of investors by providing real-time insights into their HEI portfolio, which fosters trust in the servicing process.
Moreover, the servicer should be proficient in regulatory compliance and risk management. As the HEI market continues to evolve, so will regulations that impact HEI market participants and how they operate. A subservicer that can navigate these changes effectively can help ensure both compliance and protection for all stakeholders, including homeowners.
As the market matures, it will become increasingly vital for all industry stakeholders to make sure these innovative financial products are managed with the homeowner’s, originator’s, and investor’s best interests in mind. If homes are to remain the “safest investment in the world,” it will take the collaborative efforts of the entire industry to navigate this new landscape responsibly.
