Equity-Sharing Home Loans vs. HELOCs: Building an Emergency Fund

When it comes to building an emergency fund, one option many homeowners consider is leveraging their home’s equity. Two common ways to do this are through an equity-sharing home loan or a Home Equity Line of Credit (HELOC). Both offer unique benefits, but each has its own set of considerations depending on your financial situation, goals, and the amount of flexibility you need. Let’s take a closer look at how these options work and see which option might be suitable for you.

Equity-Sharing Home Loan

An equity-sharing home loan is a financing option where a provider partners with a homeowner to access the equity in their home. With Unison, for example, you can unlock a portion of your home’s value in exchange for a share of future home appreciation when the property is sold or refinanced. This is often used for purposes like funding large expenses, paying down debt, or building an emergency fund.

Benefits of an Equity-Sharing Home Loan:

• Lower Monthly Payments: With an equity-sharing loan, the loan payments tend to be significantly lower because the principal repayment is deferred. This can free up more cash for an emergency fund without putting strain on your monthly budget.

• No Pre-Payment Penalties: Depending on the terms, some equity-sharing agreements may allow you to pay off your loan early, without added fees. It’s an added element of financial flexibility that other options may not offer.

• Access to Significant Funds: If you need a substantial emergency fund, an equity-sharing loan can provide access to a significant portion of your home’s equity. Unison, for example, can offer between $30,000 and $400,000, based on your home’s value and credit profile.

Considerations of an Equity-Sharing Home Loan:

• Shared Future Appreciation: One of the key considerations is that, when you sell or refinance, you will share a predetermined portion of your home's appreciated value with the lender.

• Origination Fees and Costs: Similar to a traditional loan, an equity-sharing home loan may come with upfront costs such as origination fees, appraisals, and closing costs. Be sure to factor these into your budget.

• Limited Geographic Availability: Equity-sharing loans from specific providers may not be available everywhere. They are currently offered in select states, which could be a limitation depending on your location.

• Long-Term Commitment: You may need to stay in your home for a longer period to fully benefit from this arrangement, especially if you want to maximize your share of the home’s appreciation.

Home Equity Line of Credit (HELOC)

A HELOC works by allowing homeowners to borrow against the equity in their property. Unlike a traditional loan, a HELOC is a revolving line of credit, meaning you can draw funds as needed during the draw period and pay them back over time.

Benefits of a HELOC:

• Flexibility: One of the biggest advantages of a HELOC is the flexibility it offers. You can borrow as little or as much as you need, making it a great option for an emergency fund. You’re only required to pay interest on the amount you borrow.

• Access to Funds Over Time: If you’re concerned about unexpected future expenses, a HELOC allows you to access emergency funds whenever needed, without applying for new loans.

• Lower Initial Payments: During the draw period, many HELOCs only require interest payments, which can make them a more affordable option in the short term.

• Lower Interest Rates: Compared to credit cards or personal loans, HELOCs typically have lower interest rates because they’re secured by your home’s equity.

Considerations of a HELOC:

• Variable Interest Rates: One potential downside of HELOCs is that they often come with variable interest rates. As interest rates rise, your monthly payments may increase, making it harder to predict your borrowing costs.

• Repayment Periods: Once the draw period ends, you’ll begin to pay both principal and interest, which can increase your monthly payments significantly. Planning for this shift is essential.

• Credit Line Reduction: If your home’s value drops or if the lender deems you a higher risk, your credit line may be reduced or frozen, limiting your access to funds.

Key Takeaways: Choosing Between an Equity-Sharing Home Loan and a HELOC for Your Emergency Fund

Both an equity-sharing home loan and a HELOC can be valuable tools when building an emergency fund, but they serve different financial needs and come with their own benefits and considerations. An equity-sharing home loan offers lower immediate payments and access to significant funds, but you must be comfortable with sharing future home appreciation. On the other hand, a HELOC provides flexible, revolving credit with lower initial payments, but it comes with the potential risks of variable rates and changes in your credit line.

Another factor to consider is the risk of foreclosure. Since both HELOCs and equity-sharing home loans are secured by your home, failure to repay the loan can result in foreclosure. This adds an element of risk, especially if you’re uncertain about your future financial situation.

Ultimately, the best option for you will depend on your financial goals, how much flexibility you need, and your comfort level with the potential risks involved. If you're considering either of these options, it’s important to assess your personal situation and consult with a financial expert to help you make an informed decision.