No interest or payments required, just a promise to share future equity
Equity sharing was viewed as the biggest negative to early reverse mortgages and it still plagues the reverse industry today. However, a San Francisco-based company is resurrecting the concept of sharing home equity — with no interest, no payments and no age restrictions.
The REX Agreement is not a reverse mortgage, nor is it a loan. It is a financial agreement whereby the homeowner trades a portion of future equity for a cash payment today. It is an intriguing option for savvy investors who believe they can realize a greater return on investments than on home appreciation.
Thomas Sponholtz, Rex CEO and a former director in Barclay’s Global Investors’ Alternative Investment Group, said he got the idea for the company after being frustrated by how institutional investors viewed home equity — the world’s largest asset class.
“We have been so concerned with how to securitize debt that I thought there had to be a better way to monetize the house and give more people access to it.”
Reverse mortgages have been provocative and their history has a lot to do with it. Some of the early reverses contained the controversial “equity share” component, giving the lender a significant portion of the appreciation in the home in addition to interest charged on any amounts already drawn and spent. Often, that equity portion was 50 percent of a rapidly appreciating home, leaving some homeowners or inheritors in debt when the senior died or moved out of the home. The equity share component no longer is included in reverse mortgages, which is a key reason for the popularity of today’s products.
Rex is betting that it can make money by investing in a geographically diverse portfolio of single-family homes and the subsequent financial benefits of future appreciation. The company simply is executing on a program based on what most economists have been preaching for years — that real estate is usually an excellent long-term investment.
In most cases, homeowners can draw 10-15 percent of the home’s value, depending upon the terms and percentage of the future equity share — get more cash now, yet be prepared to give up more of the home’s appreciation down the road. If the home’s value goes down, the homeowner and Rex share the loss equally.
The worst-case scenario would be an owner who uses the advance payment for high-risk investments. If those investments fail, and the home loses value, the owner would face a precarious position.
For home buyers, the concept can increase the amount of the down payment and reduce monthly payments brought by a lower loan amount.
The typical customer is a baby boomer, aged 50-62 with an above-average-priced home, and has significant equity and the need to increase wealth for retirement. While there is not one common target for a customer securing Rex funding, most clients have consolidated outstanding debt, purchased other real estate including second homes or paid college tuitions, according to Jeffrey P. Cusack, sales director.
Here’s how the Rex Agreement works in a typical situation: Let’s assume a home is valued at $500,000 and the owner signs with Rex for a $50,000 advance. If the house sells seven years later for $600,000, Rex gets $100,000 — $50,000 in repayment and half of the $100,000, the home’s appreciation since the deal was signed. If the value is flat after seven years, Rex gets only $50,000.
If the house’s value decreases by $100,000, Rex and the homeowner would share the loss equally — $50,000 each. Rex would receive no money upon the sale, while the homeowner would be liable for the remaining $50,000 of loss.
Homeowners can terminate the Rex Agreement at any time, but there is a stiff early exit cost if the owner opts out within the first five years of the deal. Rex charges a fee equal to 25 percent of the advance payment if the agreement is cashed out in the first year, 20 percent in year two, 15 percent in year three, 10 percent in year four and 5 percent in year five. There is no penalty after five years.
“I believe sophisticated investors would look at the repayment after the third year as palatable,” Cusack said. “If I give you $100,000 today, the market is flat for three years, and the home does not appreciate, you would owe me $115,000 after three years and have to make no payments during that time. That’s not terribly severe.”
The costs of obtaining a Rex Agreement will vary, yet a homeowner’s out-of-pocket expenses are usually offset by the option fee paid by Rex. The appraisal, preliminary title report, title insurance, credit report, natural hazard disclosure, tax service, flood certification, notary, wire, messenger, recording, escrow/closing and any other fees often are eliminated by the option fee.
Owners must continue to maintain the property, keep taxes, insurance and any mortgage payments current and not exceed the agreed-upon limit on the total principal amount of any loans that may be secured by the home.
Remember to use any home equity wisely. A terrific opportunity is not terrific if you can’t sleep at night.
Copyright 2008 Tom Kelly