Today, I’m going to share with you the story of two clients, a married couple, who, back in 2020, were in desperate need of cash to cover some credit card debt and assist their children with financial matters.

In the interest of privacy, I’m not disclosing their names. So, for the purposes of this column, I’m calling them Mr. and Mrs. Jones.

The Joneses didn’t want to touch their low 3.25% first mortgage interest rate.

Also see: Southern California homeowners have $1.645 trillion of tappable equity

So, they applied for a home equity line of credit through their bank. Wells Fargo turned them down because their debt ratio was too high (total of house payment plus other bills, divided by monthly gross income).

They turned to a home equity investment company or home equity contract company with a somewhat novel program called home equity contract (HEC) or home equity investment (HEI).

In exchange for 49% of their future property appreciation, the contractor offered an upfront lump sum of cash requiring no monthly payments and no accruing interest.

“We desperately needed the money, so we took it,” the Mr. Jones told me. “It was the only game in town.”

Here are the basics of the Jones’ deal. By appraisal, the HECC concluded the value in 2020 to be $996,000. The HECC required the couple to take a $142,000 haircut on the value (That’s the $142,000 lump sum the HECC gave to the Joneses.) So, the initial recognized value — in exchange for 49% of the appreciation — was $854,000.

The Jones are now downsizing, selling their home for roughly $1,650,000 or roughly a 65% gain.

Assuming a $1,650,000 sales price, minus the starting value at $854,000, the property appreciated $796,000 in five short years. This means the HECC will receive $390,040 for its $142,000 bet on the Joneses property appreciation. That’s a 275% return on investment, or nearly triple. Holy Toledo! 

In all, the Joneses went back to negotiate for a smaller split to the HECC firm. Their Realtor estimated they’d have about $600,000 when everything was paid off. Their annual appreciation rate was about 10.5%. In addition, the Joneses paid $3,000 in closing costs for the original HEC.

The amount of appreciation the HECC company gets varies by firm. For example, Point offers homeowners protection cap of 17% to 19% appreciation annually per annum, according to Shosi Ueki, its chief growth officer.

Hometap, another HECC company, ensures its return will never exceed a 20% annual rate, says Jonathan MacKinnon, senior vice president of product strategy and business development.

I polled several HECCs to get a sense of the program parameters. In general:

—Borrowing amounts are as low as $30,000 to as high as $500,000

—FICO scores can be as low as 500 and no income qualifying

—No age restrictions (you don’t have to be 62 as for a reverse mortgage)

—All allow owner-occupied contracts, some allow second homes, investment properties and one to four units.

—The maximum combined loan to value can vary (minimum remaining equity after the considering the lump sum payment)

—Points charged vary from 0 to 5 points (each point charged is 1% of the borrowed funds, i.e. $250,000 at 4 points is $10,000), plus escrow and title insurance type charges of roughly $2,000 to $4,000

—You must pay all the funds back at once

—No prepayment penalty

—Terms are generally 10 to 30 years

—Early payback triggering events are the home sale, home refinance or by homeowner’s choice (such as they came into money and just want to pay the funds back)

—Typically, the sales price will be the value used to measure property appreciation. Absent a sales price, then an appraisal will determine the value

According to the Consumer Financial Protection Bureau, the first home equity contract company started in 2006. In the first 10 months of 2024, the four largest home equity contract companies securitized approximately $1.1 billion backed by about 11,000 home equity contracts (averaging $100,000 per home). Still, this is an emerging market, given the small amount of fundings.

CFPB complaints shows homeowners felt frustrated and misled about various aspects of home equity contracts, including confusion about financial terms, surprise at the size of the repayment amounts, disputes about appraisal values, difficulty refinancing due to the existence of a HEC and frustration that they felt their only option to get out of the contract was to sell their home.

Truth be told, homeowners have become so overprotected through regulations on traditional mortgages, that the poorly qualified “borrowers” are between a rock and a hard place. Lousy credit and/or little or no income make it almost impossible to cash out.

HECs offer a viable way to tap equity without having to sell your property or add to your mortgage payment pressure. Just like reverse mortgages, HECs should be a “loan” of last resort. Think of it this way: Is it better to give up some appreciation than to be forced to sell your home?

This novel financing is virtually unregulated, though. One source told me there are no federal regulations or consumer protections.

If the product is being offered as a contract, and not a loan, then a broker license would likely be required; however, there are no specific disclosures required because the product is not a “loan,” according to Christina Jimenez, assistant commissioner of communications and publications at the California Department of Real Estate.

If you are considering a home equity contract, you must shop around. I was getting dizzy listening to all the nuances each home equity contract company was offering.

Just google “home equity investment” or “home equity contract.” You’ll find plenty of companies. You should create a spreadsheet to be able to properly compare.

Separately, I strongly advise you to have an attorney review the terms and explain them to you in simple English before signing anything.

Freddie Mac rate news

The 30-year fixed rate averaged 6.84%, one basis point lower than last week. The 15-year fixed rate averaged 5.97%, two basis points lower than last week.

The Mortgage Bankers Association reported a 12.5% mortgage application increase compared to one week ago.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $806,500 loan, last year’s payment was $59 more than this week’s payment of $5,280.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.875%, a 15-year conventional at 5.5%, a 30-year conventional at 6.375%, a 15-year conventional high balance at 5.99% ($806,501 to $1,209,750 in LA and OC and $806,501 to $1,077,550 in San Diego), a 30-year high balance conventional at 6.75% and a jumbo 30-year fixed at 6.5%.

Eye-catcher loan program of the week: A 40-year fixed rate mortgage, interest-only for the first 10 years at 6.625% with 1 point cost.

Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or jlazerson@mortgagegrader.com.