Investments

Council Post: Breaking The House-Rich, Cash-Poor Cycle

Isn’t it odd that until recently homeowners — after years of paying down mortgages and building equity as their homes appreciated — were unable to tap into that equity unless they either sold their house or borrowed against it? The lack of additional options to access equity forced homeowners to make tough financial decisions like forgoing home improvements, deferring the launch of new businesses, retiring later than planned and, in some cases, making hard calls around how to fund healthcare and educational expenses.

Consider how much of your paycheck is left after you’ve made your mortgage payment, shopped for groceries, and paid utility, car, and insurance bills. If your expenses are outpacing your income and you’re using credit to cover the gap until you find a way to catch up, you’re part of the more than 40% of U.S. households that carry credit card debt. The average debt for balance-carrying households was $9,333 in 2018.

Yet the average homeowner with a mortgage gained nearly $5,000 in home equity in the past year, and a growing number of homeowners are reluctant to borrow against it. This is what’s known as being “house rich, cash poor” — the feeling of having solid net worth that’s virtually untouchable.

What’s Causing It? 

Median home prices have increased 121% nationwide since 1960, and median household income has increased only 29% in that same time frame, proving that the gap between income and home costs is very much real and growing.

This prompted my home equity investment company to launch a study of 675 homeowners nationwide to gain insights into the house-rich, cash-poor phenomenon and where they’re feeling debt stress most. The results confirmed what we suspected and then some: 73% of homeowners surveyed agreed to feeling house rich, cash poor at least some of the time, and 77% said they expect the gap between home costs and wages to get worse.

What Options Do Homeowners Have? 

Homeowners looking to borrow against the equity they’ve built in their homes can go one of four ways. There’s the standard second mortgage loan, which can be a great option for someone who needs a large amount of money in a lump sum. The downside? Most lenders have strict qualifications, including FICO scores and debt-to-income-ratio maximums. These loans often come with higher interest rates, include early payment penalties and require monthly payments almost immediately.

Home equity lines of credit (HELOCs), while losing popularity, are a good option for short-term loans. They are also useful when homeowners are unsure of how much they need to borrow. These have many of the same qualifiers as home loans and can also include early payment penalties.

Refinances are a good option for homeowners who are far along into their first mortgage, have a large amount of equity and need a lump sum of capital. But they tend to come with large origination fees and can extend your debt timeline.

Our survey data showed that the majority of homeowners aren’t interested in traditional options for turning equity into cash, with 37% saying they prefer not to take a loan, 25% saying they’d rather not sell and 12% saying they have no good options. This aligns with other reports that illustrate homeowners’ distaste for solutions that create more debt.

In recent years, a fourth option has appeared that may appeal to these homeowners: home equity investments, which offer homeowners cash today in exchange for a percent of the future value of their home. While the approaches differ between home equity investment providers, most offer near-immediate cash without interest or monthly payments throughout the investment term of the agreement. While a homeowner still needs to qualify for this type of investment, the qualifications are often less stringent than those of a second loan.

However, there are some factors homeowners should consider when evaluating this option. For starters, there are a few businesses in this space, but their terms differ. So it’s important for homeowners to do their homework, compare their options and ask questions before deciding which provider, if any, is a good fit. Some providers, for example, make an investment offer based on a discounted value of the property today, while others make an investment based on the future value of the property. Closing fees and other important details also depend on the investor, so thoroughly read the terms of each.

If you’re exploring this option, it’s also important to know the scenarios in which a home equity investment isn’t the best solution. These include when the property is a vacation rental the homeowner doesn’t inhabit a majority of the time, or if the homeowner is at risk of being unable to make their mortgage payments after the investment is received. It’s also not likely a good fit if a homeowner has less than 25% equity in the property, or if the homeowner plans to stay in the home beyond the investment term (as they’ll need to refinance, use savings or take out a loan to settle the investment rather than selling the property).

It’s Time For Change

Our study’s findings showed that the majority of homeowners have ambitious financial goals that span far beyond homeownership. But all signs point to a widening gap that could push homeowners even further from those goals. It’s time American homeowners consider changing the way they think about their most valuable, but largely illiquid, asset. Until then, the house-rich, cash-poor problem will continue to make it a challenge for Americans to achieve important personal milestones.

Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms.
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