Reverse Mortgages vs. Equity Sharing Programs - Separating Fact from Fiction

Equity Sharing programs are being pitched as the new alternative to Reverse Mortgages, but what you don't know may end up costing you more than you bargained for.
March 24, 2008 - PRLog -- In an article in the Seattle Times, reporter Elizabeth Rhodes reports on the rise of equity sharing programs and how they are better than Reverse Mortgages because they don't "charge interest."  The article reads more like a cheesy sales pitch than an investigative piece of journalism and unfortunately for Ms. Rhodes she completely misses the mark on many issues.  It is always depressing when the little bit of press that gets released is so terribly wrong, and this is what continues to lead many people astray when it comes to Reverse Mortgages.

The basics of an equity sharing program are that the investor will pay a certain percentage of your homes value to you right now in exchange for you giving up a percentage of your future equity appreciation. Ms. Rhodes goes on to say "unlike a Reverse Mortgage, the Rex Agreement doesn't charge interest," but sadly this just isn't the case and, in fact, it is completely misleading.

The example that the firm and the article wanted to use is this:

"For example, the owner of a $500,000 house signs a Rex Agreement to cash out 15 percent of the home's appraised value. Tha'ts $75,000. The owner gets the money immediately; there are no restrictions on its use. Ten years later, the owner sells the house for $700,000. Rex gets the original $75,000 back, plus half the increase in the home's $200,000 appreciation, for a total of $175,000."

If you don't immediately see the problems with this scenario then you might be exactly who Rex and Co. are going after. This deal is terrible. Let me explain why:

1.) "The Rex agreement doesn't charge interest" -

What do you call it when you borrow $75,000 and ten years later you pay back $175,000? I know companies like this are very tricky and have worded things very carefully to avoid calling this interest and I'll explain why. If this were to be considered interest then it would be regulated and subject to predatory lending laws; I might argue that it still is subject to these laws but that might take a while.  The max interest rate a lender can charge on a loan is subject to restrictions and this is just a clever way to avoid that.

Lets look at how much interest you would really be paying on this deal.  You "borrow" $75,000 and you "pay back" $175,000, giving you a cost of $100,000 to borrow that money for ten years.  Although they don't call it interest, you are in fact paying an effective interest rate of roughly 8.75%. To put that in perspective, the interest rate on a fixed rate Reverse Mortgage right now is about 5.5%. The extra amount that 3.75% will cost you is about $50,000 over those 10 years -- some deal that is.

This deal gets even worse if the value of your home goes up more than expected over the next 10 years.  They are only figuring a 20% net increase in the home's value over 10 years, historically the average increase in  homes' value is about 8% annually. Of course, the current market is going to dampen that and to compare things properly a Reverse Mortgage figures an increase in your homes value at 4% annually. If we use that same 4% for the example in the article the home is actually going to be worth about $745,000 after the ten years. This means that you will  pay back more than the $175,000, closer to $200,000, all this on a "loan" of $75,000? This gives you an effective interest rate closer to 10.5%. I hope you are catching on here that the more your home appreciates the more it costs you to borrow the money. This deal is a complete gamble on your most valuable asset -- not a good idea.

2.)  You are no longer the only person with "rights" to your home. The article doesn't dicuss this in much detail but I can promise you that if this investor is going to give you $75,000 then they are going to be intimately involved in all aspects concerning your home.  You can't refinance without their permision, you can't sell the home without their agreement, you can't give the home to your family and heirs.  You have basically taken on a partner.  Your home is no longer yours in the traditional sense.  I don't know about you but I don't want someone having that much control over me and my home.

3.)  You still have to pay your existing mortgage. One of the main reasons homeowners get a Reverse Mortgage is so they can stop making mortgage payments. What's the point if you still have to keep making your mortgage payment? Why not just get a Home Equity Loan that doesn't require you taking on all the baggage here? Home Equity Loans, by the way, are at around 5.5% for qualified homeowners right now as well, much lower than what the Rex Agreement is charging. I would also be very interested to look at the contract and how they handle any missed payments on the first mortgage.  Are they allowed to foreclose or sieze the property if you are delinquent on your first mortgage?  After all, they have a lien on your property, they can foreclose if you default on the contract, and I'm sure maintaining a current status on your first mortgage is part of that contract.

4.) We hit on this a bit earlier, but it is important to note that this type of deal is not regulated by federal banking and mortgage regulations. It is regulated by consumer-protection laws, which is a BIG difference.  When you apply for a home loan you receive many disclosures designed to outline the costs of the loan. The Truth in Lending Dislcosure, the Good Faith Estimate of costs, and many other disclosures designed to protect you from predatory lending.  Also, as mentioned earlier, interest rates are regulated on mortgage loans, which is not really the case here.  You could pay as high as 20% or more effective interest rate if your home goes up in value more than you think.  Consumer protection laws are more along the lines of credit cards, and  credit card companies can get away with a lot.

5.) You have to qualify for a Rex Agreement with more than your equity. You have to have good credit, and I'm sure, good income to maintain the first mortgage. Reverse Mortgages have no credit or income requirements because there are no payments that have to be made.

6.) If your home goes down in value you still owe the money you borrowed. In this example they talk about how if your home goes down in value you don't have to pay "interest" only the $75,000 you borrowed.  This sounds nice, but Reverse Mortgages are Non-Recourse which means if your home goes down in value you don't have to pay the difference, which sounds better to me.

As you can see, this type of equity sharing program has a lot of problems. There are not the traditional banking regulations, they do not have set interest rates that you can prepare for, you do not "own" your home in the traditional sense any more, you have to continue paying your mortgage, and you have the risk of recourse in the event your home declines in value.  When you consider all the risks of this type of borrowing, it just doesn't make sense.  There are less costly forms of leveraging the equity in your home that are a lot simpler to understand. I just wish the reporter at the Seattle Times took the time to research this a little more before running a free advertisement for a deal that has the risk of ruining so many homeowners financial security.

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