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Shared equity agreements that let homeowners cash out equity in exchange for a share of their home’s future value could be on the verge of going mainstream, with the close of the first rated securitization of $224 million in notes backed by home equity agreements.
The notes were backed entirely by nearly 2,000 home equity agreements originated by Unlock Technologies Inc., issued by Saluda Grade and rated by DBRS Morningstar.
“This is a watershed moment for Unlock, Saluda and the entire industry,” Saluda Grade CEO Ryan Craft said in announcing the deal Thursday. “A home equity agreement is no longer an esoteric asset class, but a well-constructed consumer finance product that provides measurable value to homeowners and investors alike.”
For decades, most mortgages have been routinely packaged into securities that are sold to institutional investors who provide trillions of dollars in funding to the mortgage lending industry each year. Because the homes financed by the mortgages serve as collateral — and payments to investors are also guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae — mortgage-backed securities (MBS) are considered to be almost as safe an investment as government bonds, and are the bedrock of the U.S. mortgage industry.
But securitizing home equity loans or equity share agreements can be trickier, since most homeowners already have a mortgage. When providing money to a homeowner who already has a first mortgage, the lender must settle for a second or even a third lien, meaning they won’t recoup what they’re owed if a home ends up in foreclosure until after the lender providing the first mortgage is repaid.
Equity share agreements add another layer of complexity, since rather than taking out a loan, homeowners agree to give up a share of their property’s future value. That means the originator’s returns depend on how much a home’s price goes up — or down — over time.
Of the 1,984 home equity contracts originated by Unlock and securitized by Saluda, just 221 were first lien contracts in which the homeowner did not have a mortgage. The remainder were second (1,525) or third lien (238) contracts.
DBRS Morningstar, which in July became the first (and so far only) rating agency to come up with a methodology for evaluating securitizations of home equity investments, rated $152.5 million of the Class A notes issued by Unlock HEA Trust 2023-1 as “BBB (low).”
That means DBRS Morningstar analysts consider the Class A notes to be of “adequate credit quality,” with “acceptable” capacity for repayment that “may be vulnerable to future events.” Another $31 million in Class B notes were rated “BB (low),” meaning they are considered to be “speculative, non-investment grade credit quality” with uncertain capacity for repayment that will be “vulnerable to future events.”
While this was Saluda’s third securitization of home equity agreements originated by Unlock, it was the first time a rating agency had weighed in — giving institutional investors like insurance companies, mutual funds, credit funds and asset managers confidence that the risks have been analyzed and quantified.
“A rated securitization is the only way for an asset class to become mainstream,” Craft said.
Rated securitizations are also providing a funding boost for lenders who offering home equity loans and home equity lines of credit (HELOCs). While those loans have traditionally been provided by banks that hold the loans on their books, a number of big nonbank mortgage lenders including United Wholesale Mortgage, Rocket Mortgage and loanDepot have gotten into business of providing home equity loans or HELOCs.
Figure Technologies, which claims to be the nation’s largest nonbank provider of HELOCs, announced its first rated HELOC securitization in April, consisting of notes backed by 3,568 loans with a total credit limit of up to $246.2 million.
Figure, which works with private label partners including CMG Financial, CrossCountry Mortgage, Fairway Independent Mortgage, Guaranteed Rate, Homebridge, The Loan Store, Synergy One and Movement Mortgage, said in July that it’s provided more than $6 billion in HELOCs to about 85,000 households.
With U.S. homeowners sitting on an estimated $10.5 trillion in tappable equity, helping them cash out is a big business. But rising interest rates have made it more costly for homeowners to convert their equity into cash by borrowing against their home.
Home equity lending dwindles
Black Knight estimates that before interest rates began their meteoric rise last year, Americans cashed out $79 billion in equity during the first quarter of 2022 using first lien cash-out refinancing, second lien home equity loans or HELOCs. But by Q2 2023, equity withdrawals on mortgage properties had dwindled to about half of that — $39 billion.
Because shared equity agreements allow homeowners to turn equity into cash without taking a loan, Unlock and rival providers say they’re an attractive alternative to mortgage refinancing or home equity loans, accessible to homeowners with modest incomes or flawed credit.
“Traditional solutions have focused on swapping one kind of debt for another, which keeps the consumer on the debt treadmill,” Unlock CEO Jim Riccitelli said in a statement. A home equity agreement “is not debt, and it’s not a debt consolidation product. It’s a debt elimination product.”
When it’s time to settle up — Unlock clients have up to 10 years to close out their contracts — providers of shared equity agreements can walk away with big profits.
Unlock typically gets a stake in its clients’ homes that’s about double the value of the cash it provides upfront.
As the company explains in its product guide, at the typical “exchange rate” of 2.0, a homeowner who receives cash equal to 10 percent of their property’s current value gives Unlock an ownership stake equal to 20 percent of its future value.
Unlock also charges a 4.9 percent origination fee and third-party expenses which are taken out of the cash homeowners receive. So when Unlock makes an upfront investment of $100,000, the net cash proceeds to the homeowners might be closer to $93,000, the company says.
Competitors include Hometap, Splitero, Unison, Spring EQ and Point, which partnered with Redwood Trust Inc. in 2021 on what the companies claimed was the first-ever securitization backed solely by residential home equity agreements.
In announcing the sale of Spring EQ to an affiliate of Cerberus Capital Management last month, Saluda Grade said it had helped securitize more than $725 million of Spring EQ’s home equity originations, including the first rated securitization of newly originated second lien mortgages since the global financial crisis.
Fannie Mae and Freddie Mac’s regulator, the Federal Housing Finance Agency (FHFA), is proposing to lift restrictions that prevent the mortgage giants from buying shared equity loans. Fannie and Freddie see the loans as a way to help would-be homebuyers in pricey markets by letting them pledge a share of their future home price appreciation to investors.
The mortgage giants purchased close to 600 shared equity loans between 2018 and 2020 before realizing that in many cases, current regulations prohibit them from buying loans encumbered by private transfer fee covenants (PTFCs) used to enforce the shared equity agreements.
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