‘Equity release’ is the newest way to turn your home into a piggy bank. But the risks can be sizable.
By ANNE TERGESEN
September 13, 2008; Page R6
When Gladys Tully needed cash for some home projects, the 72-year-old decided to tap into the value of her $800,000 home near San Diego.
But rather than use a home-equity loan or reverse mortgage, Ms. Tully opted for a new product, frequently called a shared-appreciation arrangement or equity release, which is gaining popularity among homeowners in or near retirement.
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Although different companies structure the transactions in different ways, the premise of the arrangement is the same: A homeowner agrees to give up part of a home’s future appreciation in exchange for cash — typically 10% to 15% of the property’s current value.
When Ms. Tully signed on early this year with EquityKey LLC, a real-estate investment company in San Diego that offers shared-appreciation arrangements, the former travel-agency owner received $106,000, or about 13% of her home’s value. In exchange, EquityKey will pocket half of any future increase in the home’s value — taking its share when Ms. Tully sells the house or terminates the agreement.
"I could have sold some of my investments to pay for these extras, but that’s what I live on," says Ms. Tully, who enjoys painting and travels frequently.
What to Consider
Shared-appreciation agreements can make financial sense for some older adults. For one, they offer some protection against the current turmoil in real-estate markets. If a property’s value has declined by the time the owner decides to sell it or terminate the contract, the homeowner gets to keep some or all — depending on the product — of the cash he or she is given upfront. What’s more, homeowners aren’t saddled with monthly payments, as in the case of a home-equity loan. And closing costs are typically less than that of a reverse mortgage.
But these deals also carry considerable risks, according to some real-estate experts. In the first few years of a contract, lenders are generally protected from bearing their share of the losses. And if a home appreciates over the life of an agreement, this approach could prove more costly than a conventional loan.
"From the perspective of the companies, this may be a very good time to do these deals," says Susan Wachter, a professor of real estate at the University of Pennsylvania’s Wharton School of Business in Philadelphia. "When prices rebound, they will capture that in their share of the appreciation."
For clients, she adds, "it’s another one of those products that reduces the use of the home as a vehicle to save. At this moment in time, people may flock to this, but it would be really myopic to simply look at the experiences of the past year or two as an indication of the evolution of home prices."
Worried about the housing downturn, some homeowners are using the arrangement to cash in a portion of their home’s current value. Others are investing the money they receive in stocks or other investments they expect to outperform residential real estate. Some others are trading away future profits to pay down debt and fund indulgences, such as renovations and vacations.
The number of companies offering these profit-sharing arrangements has risen to three from one during the past 18 months — EquityKey; Rex & Co., a real-estate company based in San Francisco; and Grander Financial Inc., a financial-services company in Irvine, Calif. A fourth, NestWorth Inc. of San Francisco, plans to enter the market by year end.
The firms decline to say how many clients they have enlisted. But EquityKey says in the first six months of 2008, applications jumped 112% from the year-earlier period. At Rex, the dollar value of deals completed in the first half of the year rose 20% from all of 2007. The products are sold mainly to people in or near retirement. Applicants to NestWorth and EquityKey must be at least 60 and 65, respectively. At Rex, which has no age restrictions, the average client is 56.
"This is an area…that’s just being discovered in financial-services circles," says Peter Bell, president of the National Reverse Mortgage Lenders Association, a trade group based in Washington, D.C. "I think we’re going to see a lot of innovation in this area in the next couple of years."
Cheaper Than Loans?
In promotional material, these agreements present themselves as an alternative to debt. But that doesn’t necessarily mean they will prove any cheaper than a conventional loan.
Take George Lifshutz’s Rex agreement. A year ago, the retired New York City police officer pocketed $38,000 from Rex in return for signing away half of the future gains on his home in Sunrise, Fla. Since then, the plummeting housing market has reduced the home’s estimated $295,000 value.
The terms of his agreement call for Mr. Lifshutz to repay the $38,000 — plus Rex’s share of the profits or minus its share of the losses. With Mr. Lifshutz’s home now worth less, he can deduct Rex’s piece of the loss from the $38,000 he borrowed. That isn’t a bad deal, considering that with a conventional loan, he would have to repay the $38,000 plus interest.
Still, unless Mr. Lifshutz sells his home, Rex can delay his repayment until the contract’s fifth anniversary. By then, there’s a good chance that home values in many parts of the country will have recovered.
Many economists expect home prices to turn around by late 2009 or early 2010, unless the economy enters a deep slump. In the coastal regions in which EquityKey, Rex and their rivals concentrate, the turnarounds could prove especially dramatic.
"In these supply-constrained states, annual price increases of 5% to 10% aren’t unusual," says Prof. Wachter. For those who need the appreciation from a home to pay for assisted living or long-term care, she adds, the notion of trading it away makes little sense.
What if property values rise over the course of an agreement?
Consider a homeowner with a $500,000 home. Under an agreement with Rex, he or she would receive $62,500 in return for signing away half the home’s future gains. Assuming the home appreciates by a relatively modest 3% a year, the home would be worth $671,958 in a decade. At that point, the homeowner would, at least on paper, owe Rex $148,479. That’s $62,500 for the cash advance, plus Rex’s half of the home’s gains.
With a government-insured reverse mortgage — a loan in which equity is converted into cash and a bank makes payments to the homeowner — the same person would owe just $126,676, according to Jerry Wagner, president of Ibis Capital, a San Francisco-based developer of software for reverse mortgage lenders and counselors.
Potentially ‘Very Expensive’
The homeowner would also come out ahead with a home-equity loan. With an 8.06% interest rate, the going rate these days, someone borrowing $62,500 would repay $91,234 in principal and interest over 10 years, says Keith Gumbinger, vice president of HSH Associates, a publisher of mortgage information. Shared-appreciation agreements, he adds, are "potentially a very expensive source of money."
There are other potential downsides. Because the tax code doesn’t specifically address these arrangements, there’s a risk the Internal Revenue Service could require homeowners to pay tax on the upfront payments. The companies, citing opinions from law firms they employ, maintain that no tax is due until the home is sold or the agreement is terminated. And at that point, the company and the homeowner each would pay the capital-gains tax rate on their respective shares of the profits.
Then, there’s the matter of control. As lien holders, EquityKey and its peers have the right to look over a homeowner’s shoulder — and even call some of the shots. Rex, for one, caps the amount of mortgage debt its clients can carry — the percentage varies by transaction. If an owner fails to pay the property taxes or perform any necessary repairs, the companies can pay the bills for him or her — and deduct the costs from the owner’s share of the pie. In extreme situations, such as a mortgage default, they may even sell a home.
Additional Fees
Closing costs on these transactions are relatively modest. Fees range from $300 at EquityKey to as much as 3% of the upfront payment at Rex. But those who sell or otherwise seek to close out these transactions before five years have elapsed may be slapped with additional fees — amounting to as much as 5% of a home’s value at the time the agreement was made. And no matter when a home is sold, the homeowner will be on the hook for all the real-estate commissions and fees, which can add up to as much as 6% of the home’s sale price.
With EquityKey, homeowners face another issue. The company doesn’t generally require clients to return the upfront payment. But because it won’t make much money if a client dies before his or her property has appreciated much, EquityKey buys life insurance policies on its clients.
As a result, the company turns away those who aren’t healthy enough to secure coverage at reasonable rates — as it turns out, more than half of its applicant pool. And those who sign on only to decide later to buy a life-insurance policy for the benefit of their heirs may discover that they have already used up much of the coverage an insurance company will sell them.
"If you die tomorrow, I will get burned on your real estate," says Jeffrey Nash, co-founder of EquityKey, "but I will make money on your insurance policy."
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