Home equity investments are a growing alternative way for US homeowners to tap into the value in their homes, and are proving popular as interest rates remain high.
The recent interest in securitizing HEI contracts is an opportunity for residential mortgage-backed securities investors to diversify, and they are gaining an image as a respectable product.
The allure of HEI to a certain segment of homeowners is simple: they can release a lump sum of money tied up in their homes, in exchange for giving up a share of the equity, which is repaid when the home is sold.
The main players offering HEI contracts to homeowners are Aspire, Hometap, Unison, Unlock and Point.
Receiving cash upfront through HEI makes sense for some homeowners. Many experienced the rapid rise in house prices during the pandemic. Despite the recent interest rate hiking cycle, prices remain high, and look set to stay that way.
Even with borrowing costs high and housing less affordable than normal, Bank of America research notes a build-up of household wealth and wealthy homebuyers, which are sustaining home prices amid constrained inventory. Prices in March were up 5.4% year on year. And BofA points out that monthly new housing supply remains historically low.
Many homeowners also secured historically low mortgage rates during quantitative easing. Refinancing that mortgage at the present higher rates would be uneconomic, causing their monthly payments to balloon. So would taking out a home equity line of credit (Heloc). Mortgage rates remain in the 7% region, a level not seen since the early 2000s.
And there is plenty of equity around.
According to a TransUnion Home Equity Trends Report published in March, US tappable home equity in the fourth quarter of 2023 was up 4% in a year and 48% over four years. And the total value is … wait for it … $20tr.
All this adds up to a ripe new opportunity for securitization.
According to Morningstar DBRS, Unison was the first company to offer the product, back in 2007. But it was only in 2015 that the concept really began to gain traction when Point began issuing contracts consistently.
An inflection point came when Saluda Grade issued the first rated HEI securitization in September, raising $153m with its Unlock HEA Trust shelf.
It legitimized HEI as an asset class in the eyes of institutional investors, opening up securitization as a new source of capital and liquidity for HEI players.
Nevertheless, for investors the asset class is a new kid on the block. So far, only a handful of issuers have followed and it remains a niche product.
HEIs are not loans, but asset-based contracts. The providers put less emphasis on a borrower’s creditworthiness, so a wider range of homeowners can take out a contract, to use the money for various purposes, such as repaying other debts, home renovation or retirement.
HEIs are a very new asset class, exposed to risks that agency MBS do not have. They are non-recourse contracts, typically backed by a junior lien on the home.
Investors stand to be repaid later than senior mortgage lenders, and are low on the foodchain for recoveries after a default.
Morningstar’s Primer also notes that HEI products lack historical financial performance data going back before the 2008 financial crisis. There are uncertainties about what happens if a contract survives until its maturity date, as the overwhelming majority are resolved earlier.
Despite these risks, HEIs have something to offer MBS investors. Used to buying debt products where the best outcome is being repaid at par, they can use HEIs to get exposure to the equity upside of the housing market, and receive returns correlated to the Home Price Index.
There is also enormous room for growth. Morningstar DBRS’s estimate is even higher than TransUnion’s: it puts the US housing market at $47tr, with around $12tr of mortgage debt, leaving total equity closer to $35tr.
The product is likely to run and run, especially if it gets a good push from sustained high interest rates, which make alternative ways of tapping home equity unattractive.
And from the investor’s point of view, the metric to watch is home equity. As long as that keeps rising, the market will have a following wind.