Home equity products enable homeowners to unlock the value of their homes through a variety of financing contracts. Each product has distinct features, benefits, and risks. In this post, we compare and contrast common home equity products, including home equity lines of credit (HELOC), closed-end home equity loans (HEL), reverse mortgages, and home equity agreements (HEA). Each of these products has any number of variations, and as a result, this post is only intended to describe the products at a high level and provide an informational overview of the most common features and considerations associated with each product.
Home Equity Line of Credit (HELOC)
- Structure: HELOCs provide a revolving line of credit, similar to a credit card, secured by a home’s equity.
- Disbursement: Borrowers can draw funds as needed up to a set limit during a “draw period” (typically five to10 years). During the draw period, repayment of amounts advanced make the funds available to borrow again.
- Repayment: Interest-only payments may be due during the draw period; principal and interest payments are owed during the repayment period (often 10-20 years).
- Interest Rate: Rates are usually variable and fluctuate with market rates. However, some HELOCs are now being offered at fixed rates.
- Consumer Uses: Homeowners leverage HELOC products to fund ongoing expenses, such as home renovations and tuition.
- Applicable Laws: TILA and Regulation Z apply to HELOCs. The laws require certain disclosures, periodic statements, and a right of rescission, and impose certain advertising rules. However, some TILA and Regulation Z requirements do not apply to HELOCs, including the Ability to Repay Rule. Some portions of RESPA and Regulation X apply to HELOCs, but the mortgage servicing rules (12 CFR § 1024.30 – 1024.41) exclude “open-end lines of credit (home equity plans)” from their definition of a “mortgage loan.” Many states also have laws specifically governing HELOCs as well.
- Pros: They provide flexibility, and interest is charged only on what consumers spend.
- Cons: Variable interest rates can result in uncertainty and increase payments, risking foreclosure if the homeowner defaults.
- Regulatory Landscape: The laws and regulations around HELOCs are well-developed, from both the federal and state perspective.
Home Equity Loan (HEL)
- Structure: An HEL is a lump-sum loan secured by a home’s equity.
- Disbursement: There is a one-time payment of the full loan amount.
- Repayment: Fixed monthly payments of principal and interest are due over a set term (typically five to 30 years).
- Interest Rate: The interest rate is fixed, providing predictable payments.
- Consumer Uses: These loans are typically for large, one-time expenses (e.g., debt consolidation, major home improvements).
- Applicable Laws: Because they are closed-end credit, TILA, RESPA, and their implementing regulations fully apply to HELs. State laws on mortgage loans will also apply.
- Pros: Payments are predictable with a fixed-interest rate.
- Cons: Because there is less flexibility, consumers must pay interest on the full amount beginning at origination, and there is a risk of foreclosure if the homeowner defaults.
- Regulatory Landscape: Because they are a form of closed-end mortgage loans, the laws and regulations around HELs are generally well-developed, from both the federal and state perspective.
Reverse Mortgages
- Structure: Loans are generally available to homeowners age 62+, allowing them to convert home equity into cash.
- Disbursement: Disbursement options vary, including a lump sum payment, monthly payments, a line of credit, or a combination.
- Repayment: There is generally no monthly payment required; the loan is repaid when the homeowner sells, moves out, or passes away.
- Interest Rate: The rate can be fixed or variable.
- Consumer Uses: Consumers can supplement retirement income to cover living expenses.
- Pros: Typically, there are no monthly payments, and allows access to cash in retirement, often non-recourse (prevents homeowners owing more than their homes’ value). No minimum credit score required.
- Cons: Home equity is reduced, fees can be high, heirs may inherit less, the home must be maintained, and taxes/insurance must be paid.
- Regulatory Landscape: Most reverse mortgages are insured by the Federal Housing Administration (FHA), and approximately half of the states across the country have enacted statutes governing reverse mortgages.
Home Equity Agreement (HEA)
- Structure: Homeowners receive cash in exchange for a share of their home’s future appreciation.
- Disbursement: There is a lump-sum payment, but typically no monthly payments.
- Repayment: Consumers must repay the HEA company the original amount plus an agreed share of home appreciation when the home is sold, refinanced, or after a set period of time (usually 10–30 years).
- Interest Rate: There is no traditional interest rate imposed. The repayment amount is based on the home’s value at the end of the agreement. However, some states have taken the position that the appreciated value of the home could be considered interest, potentially creating usury-compliance concerns.
- Consumer Uses: Consumers can access cash without monthly payments or new debt.
- Pros: There are no monthly payments, and it offers flexible use of funds and no interest.
- Cons: Homeowners must share a percentage of their appreciation, there may be restrictions on home use or improvements, and HEAs are not available everywhere.
- Regulatory Landscape: HEAs are a relatively new consumer product and regulation of the space is in its early stages. There are only a handful of states that have laws, public comments from regulators, pending legislation, or pending regulations regarding HEAs. Therefore, this is an area to watch for future activity as to whether the products require licensing and regulation for origination and servicing.