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How the cost of a home equity investment is calculated

The share percentage, the risk-adjusted starting value, and the growth of the house set what you repay. Here is the formula and what it produces under flat, slow and fast markets.

01The three parts of the formula

Every contract in this category comes down to three numbers: the cash you receive, the investor's percentage, and the value the percentage is applied to at settlement. The first is easy. The second and third are where providers differ, and where the cost lives.

The investor's percentage is set as a multiple of what their cash represents. If $50,000 is 12.5% of a $400,000 house, a provider might take 25 to 45% of future value. The multiple is their return for waiting years with no payments and for sharing the risk of a drop.

The value at settlement is the appraised value at the time, or the sale price if you sell. But most contracts first mark the starting value down, typically by 10 to 20%, before measuring any change. That markdown is the risk adjustment.

02Two models: share of value, share of appreciation

Some providers take a percentage of the whole home value at settlement. Others take back their original cash plus a percentage of the appreciation above the starting value. The two can produce similar numbers once the risk adjustment is in, but they behave differently in a flat market.

Under a share-of-value model on a flat market, you owe the percentage of the full value, which can be noticeably more than the cash you received. Under an appreciation model on a flat market, you owe roughly the cash back plus the share of the paper gain created by the risk adjustment. Ask which model your contract uses and have the provider show both numbers.

03Worked ranges on a $400,000 house

Assume $50,000 of cash, a risk adjustment that sets the starting value at $340,000 to $360,000, an investor percentage between 30 and 40%, and settlement after 7 years.

What $50,000 costs at settlement
House growsValue in 7 yearsInvestor's shareEffective cost per year
0% a year$400,000$55,000 to $75,0001 to 6%
3% a yearAbout $490,000$85,000 to $110,0008 to 12%
5% a yearAbout $560,000$105,000 to $135,00011 to 15%
8% a yearAbout $685,000$130,000 to $170,00014 to 19%

Read the right-hand column against a line of credit at 7 to 11%. In a slow market the investment is in the same neighborhood. In a strong one it is roughly double. In a flat one it is close to free, which is the scenario the investor is taking on risk for.

04The cap, where there is one

Some providers cap the effective annual cost, often somewhere around 15 to 20% a year, compounded from the funding date. If the formula produces a figure above the cap, you pay the capped amount instead. In a market growing 8% or more, the cap is what you are actually paying, and the share percentage stops mattering.

Contracts without a cap leave the top open. On a long hold in a hot market, the share can reach three or four times the cash received. If you expect strong growth and a long stay, a cap is worth paying a slightly higher percentage for, and a line of credit is worth another look.

05What to ask for in writing

  • The starting value after the risk adjustment, in dollars
  • The investor's percentage, and whether it applies to total value or to appreciation only
  • The settlement figure at year 5 and year 10 under 0%, 3% and 6% annual growth
  • The cap, if any, and how it is compounded
  • The floor, if any, if the house loses value
  • Who chooses the appraiser at settlement, and what happens if you disagree with the number

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Related

  1. What “no monthly payment” actually meansHome equity investments advertise no monthly payment. That is true. The cost shows up later, as a share of your home's future value.
  2. Buying out a home equity investment before you sellYou can end the agreement early with cash, a refinance, or a line of credit, at a price set by an appraisal. In a rising market, early can be the cheapest exit. In a flat one, waiting can cost less.
  3. HELOC vs. home equity investment: which one costs you lessA HELOC is usually cheaper if you can carry a payment and your credit qualifies. A home equity investment costs more later and asks for no monthly payment.

This path, in order

Home equity investment: the full guide

  1. 01What “no monthly payment” actually meansHome equity investments advertise no monthly payment. That is true. The cost shows up later, as a share of your home's future value.
  2. 02How the cost of a home equity investment is calculatedYou are here
  3. 03Selling a house with a home equity investment on itThe investment settles at closing from the sale proceeds, after the mortgage. Here is how the sale price sets the number, what happens if the house lost value, and how the timing works.
  4. 04Buying out a home equity investment before you sellYou can end the agreement early with cash, a refinance, or a line of credit, at a price set by an appraisal. In a rising market, early can be the cheapest exit. In a flat one, waiting can cost less.
  5. 05Credit under 660: what your options really areMost HELOC lenders want a 660. Below that, home equity investments and debt resolution stay on the table. Waiting can be the cheapest move.
  6. 06Home equity investments and taxes, in plain termsThe cash you receive is generally not treated as income, and the settlement years later can change your gain when you sell. The outline, without the advice.