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Homeowners Offered New Way to Tap House's Equity

Like most long-time homeowners, Dan and Jody Dollar have built up quite a lot of equity in their Newbury Park, California, home.

They've lived in the house for 24 years, come close to paying off the mortgage, and watched its value go up from $160,000 to almost $700,000.

That was equity they wanted to tap to pay off the family cars and buy some new equipment for Dan's physical therapy practice.

AP

But they didn't want to get into a costly reverse mortgage.

Instead, the Dollars signed up for a relatively new product called a Rex Agreement.

It gave them $117,000 in cash to spend however they wanted, and they owe no payments until they sell the house.

At that time, they'll owe Rex & Co. the $117,000 plus half of the appreciation in their home's worth between the time they signed the agreement and the time they sell the house.

If the house goes down in value, Rex & Co. will eat half of that loss as well.

Since they signed the agreement last October, prices in their neighborhood have dropped.

So far, it's been a good deal for the Dollars (yes, that's their real name.) Rex is the first of several new products on the market aimed at this shared equity or shared appreciation concept.

Others are Equity Key and My Equity Freedom.

They all have differences in the way they are structured, but all aim to replace interest payments (and high reverse mortgage costs) with an unknown share of future profits.

It's a risk for the issuers, but homeowners who enter these agreements have risks, too.

For starters, the timing of these deals might be bad for homeowners.

Home prices have been falling by historically high percentages in the last two years, and many economists are predicting inflationary times ahead. That could signal another round of increases in home prices.

Mortgage rates remain near historic lows. So homeowners entering these deals might be establishing a low baseline for their home's value and giving up sizable increases in future equity just to avoid locking in a low interest rate now.

Some folks may still want to do that.

Older homeowners who want to stay put through retirement may have too much equity in their homes, may need to take cash out to live on, and may not be in a position to make monthly payments.

The average homeowner has 50 percent of his home's value in equity, says Rex & Co's managing director, Jeffrey Cusack.

The average homeowner has 80 percent of his net worth tied up in his house.

That might be out of balance, so selling part of that equity for cash now could make sense. But first, here are some points to consider.

Do The Math

Under the Rex Agreement, a homeowner with a $500,000 house can get $71,429 now in exchange for a 50/50 split on the home's appreciation (or depreciation) going forward.

Over the last 20 years, single-family home prices have gone up 6.5 percent a year, according to industry data compiled by data360.org.

If the home appreciates 6.5 percent a year for 10 years, that means that in 2018, the home would be worth $938,568.

The homeowner would owe Rex $71,429 plus $219,284, half of the appreciation, for a total of $290,713.

If, instead, the homeowner borrowed $71,429 at 10 percent interest—higher than the current going rate for second mortgages for good credit risks — he would end up paying $41,844 in interest, for a grand total of $113,273.

Why the huge disparity? Part of it is because these figures don't account for the time value of money; that the homeowner would be paying off that loan over 10 years and not at the end of 10 years.

But most of it is because the shared appreciation agreement effectively leverages the issuer's money: They're giving the homeowner roughly 14 percent of the home's value and getting appreciation on 50 percent of its value.

In effect, though the deal isn't structured as a loan, they are "lending" $71,429 but getting an expected 6.5 percent interest on $250,000.

Ask Yourself Why You Need The Money

If you're giving away one appreciating asset to pay for another, say, to buy a second retirement home, pay for an education or build a business, it might make sense.

If you're buying a depreciating asset like a car? Not so much.

Ask yourself, also, if you'll need the value of your house in the future.

Young retirees —the typical Rex Agreement customer is in his late 50s —might need the full appreciation of their homes when they are 75 or 80 to trade into an assisted living facility or pay for long-term care.

Check The Fine Print

That big check you might be writing in the future doesn't account for all of the costs of the agreement.

Closing costs in the Rex Agreement are negligible; the company pays most of them. Other firms have different arrangements and could charge as much as $4,000 up front.

Make sure that an independent company is doing the home appraisal on which the deal is based. Find out how the deal would be affected if you spent money improving your home.

And find out how long you have to stay in the deal (most require at least three years), and how you can buy your way out of it if you change your mind later.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.