Homeowners who have been fortunate to own their homes for awhile are probably sitting on a lot of home equity. Even with the cooling off of the real estate market across the nation, the home is still most people’s biggest asset. That is the good news, but how do we get to and use that equity. There are two ways you can turn that equity into cash.
- Sell your house
- Take out a home equity line or loan against your house
There are several problems with these two options. If you sell your house, you have to find another house to live in. You can downsize and buy a cheaper house leaving you with extra cash to spend. However, most people especially young families need a bigger house, not smaller. In order to buy a bigger house, most people need to use all their equity to purchase a new house. Taking out a home equity line or loan against your house is easy to do, but it creates some new problems. First, you will have to make higher interest payments and increase your debt. Many people have taken out equity loans in recent years to access their equity, but many have overdone it. They have used their home equity like an ATM machine drawing cash out to pay for vacations, new cars, and other gadgets. With the rate of appreciation slowing, many people have spent most of their equity with little to show for it except higher debt payments, and a higher mortgage balance. They have effectively drained their biggest asset with compulsive spending.
Until recently, these were the only options to access your home equity. I just came across a new financial product that gives homeowners another alternative to access their home equity. An investment company, Rex & Co. which is a subsidiary of insurer American International Group has introduced a new product that will allow homeowners to tap into their home equity without moving or taking on additional debt.
How it works is that Rex & Co. will pay homeowners cash now in exchange for part of the proceeds of the when the home is eventually sold. A value is determined by appraisal now, and Rex & Co. gets a percentage of the appreciation(up to 50%) beyond the value of the house now. The more you borrow, the more you give up in future appreciation. Here is a calculator that determines how much cash you can receive on the value of your home, and how much of the future appreciation you retain. They also share the risk of declining value of the house. Here is a example of how this would work.
This is a new financial product, and not available in all states yet, but the company plans to offer it to all states in the next few years. As with any financial tool, there are pros and cons to utilizing this, and much of it has to do with your individual circumstances but here is my view on this new product.
My View:
I believe you have to be careful about tapping into your home equity. It is most likely your biggest asset, and you need to protect your equity. Just becaue its avaliable does not mean you are to use it to buy cars, and vacations, things that cost you money by stripping your equity, and does not make you any money in the short or long term.
That said, I think it can be a good financial tool if used prudently. The advantage of this product is that you can access the equity in your home without taking on additional debt, and no interest payments. The proceeds are really tax free. You can use the proceeds any way you wish. The company will share any decline in market value so you are somewhat protected.
The downside is that you will give up some of your home’s appreciation in the future. However, if you have owned your home for a number of years, you will already have significant equity which you will not have to give up. You only have to give up a portion of future appreciation in exchange for cash now. Furthermore, if you believe the real estate market will be flat, or declining as many experts do in the near future, you many not be giving up that much in appreciation. It is certainly an attactive alternative to a reverse mortgages with its very high fees.
I think the key to determining if it is a wise choice to tap your equity this way, is what you do with the proceeds. If you can invest those proceeds into a new business or investment that pays more than the loss in future appreciation, than it is worth considering. A sophisticated investor or businessman can cash out of his home tax free, without taking on additional debt or interest payments, and without selling his house. Using those proceeds and diversifying into other investment areas which may bring superior returns, and protect against a decline in your home’s value may be a wise move.
For more information on the is product, click here.
With this product what you’re essentially doing is selling part of your house to Rex & Co. The real value in homeownership is in future appreciation, and that is the part that you’re giving up in return for cash today.
I looked at an example, in which they indicated that a customer could get $ 33 thousand in exchange for giving Rex & Co. rights to 50% of future appreciation on a $250 thousand house.
Assuming the house appreciates at around 5.5 percent (around the historical average) the homeowner would break even in around 5 years (giving up half of $76 thousand in appreciation). After that it’s gravy for Rex & Co.
I’m not sure if there is a clause that would prevent you from taking the $33 thousand then selling the house a month later, which would virtually ensure a big loss for Rex & Co.
Bottom line: structures like this can be great if they’re used right. Negative amortization ARMS, for example, were actually sophisticated tools which were created by to help high net worth individuals manage their cashflow, but ended up being hawked to subprime loan candidates. But generally speaking when I see a product like this I tend to smell trouble.
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