Clients Who Can’t Refinance Because of Rising Mortgage Rates and Inflation Have a Solution – Home Equity Agreements
When the Fed raised interest rates by a half-point in May, it was the largest increase in more than 20 years. Then, June came, and policymakers lifted rates again, only this time by 75 basis points. With the latest CPI print coming in hot, most expect a hike of at least that much next time around.
While these moves may be good monetary policy – clearly, inflation is a problem – it creates another pressure point for homeowners feeling squeezed by pandemic-related financial stress. Indeed, with rates expected to continue to rise in the months ahead, the refinancing window is closing fast for homeowners.
The average 30-year fixed mortgage rate is about 5.75%, a three-point jump since the beginning of last year. That rate, of course, is only for highly qualified borrowers.
Anyone else will pay far more. A quick move like that has massive implications for homeowners saving for retirement who want to be able to breathe a little easier by getting their finances in good shape.
Home Equity Agreements (HEAs)
As of April, Americans had nearly $27 trillion in home equity. Over the year, many took advantage of a cash-out refinancing option when interest rates were still low.
With interest rates rising, however, refinancing is less attractive. And for those already struggling financially and hoping to lower their payments, it could soon be close to impossible. For folks like this, home equity agreements (HEAs), also known as home equity investments (HEIs), are an alternative.
A HEA is not a loan, nor is it a debt instrument. Instead, it is an agreement between an institutional investor and a homeowner, where the former provides the latter a lump-sum payment for an equity stake in their property.
The homeowner can then use the cash to pay off other debts, which will allow them to raise their FICO score and eventually make them eligible for more favorable refinancing rates. After a pre-determined period, both parties can extend the agreement, with the homeowner buying back the equity stake via a refinance, with cash or by selling the property and dividing the proceeds accordingly.
Often, media coverage of the industry tends to spotlight the firms that manage billions or clients with millions to invest. But the reality is that the overwhelming majority of Americans have far fewer resources but still work with a financial advisor.
Therefore, even as HEAs are not going to be a good fit for everyone (what financial product is?), some financial advisors and their clients should take the time to learn more about them. Indeed, most investors aren’t worried about elevated, sometimes nebulous considerations such as creating a legacy. Their concerns are more basic, like being able to pay down debt or investing enough each month to retire someday.
Consider the Risks
Still, HEAs are not a foolproof solution for clients in need of a cash infusion to alleviate financial issues.
A housing market collapse, like the one in 2008, could adversely affect values and leave homeowners underwater. If an HEA term expires during a period like that, a client homeowner may not raise enough through sale proceeds to cover the mortgage and repay the HEA stake (though a client and HEA investors may be able to explore other exit options than selling the property).
Rising interest rates will be part of the economic landscape in the future, limiting options for homeowners and clients to access capital. At the same time, lender-credit policies are becoming more restrictive. But clients with compromised credit scores and high debt-to-income ratios do have options.
Ashley Bete is a 20-year veteran of the financial technology industry. He is Founder and CEO of Leap, a fintech real estate investment firm that seeks to transform the home finance marketplace and empower historically underserved communities to help close the wealth gap.