Offer of cash for a share in future equity growth carries risks for homeowners

Second of two parts

-- When an investor offers you $50,000 or $100,000 in exchange for 30% to 50% of your home's future appreciation, is it a good deal?

That's what a new breed of investment firms is promoting as an alternative to traditional home equity loans, lines of credit and reverse mortgages. The companies contend that sharing future growth in value is a superior way to convert current equity into spendable money because there are no monthly payments or interest charges, fees are comparatively low and investors agree to participate in losses in a home's value as well as in gains.

Two of the investment companies -- Rex & Co. and Grander Financial -- are targeting owners in their 50s and younger who are ineligible for reverse mortgage programs that are restricted to people 62 and older.

But are there drawbacks that homeowners need to consider? Absolutely. Start with the core concept of "no interest" being charged on the lump-sum amounts that homeowners receive. Is $50,000 today in exchange for half of all future appreciation on a hypothetical $500,000 house worth it?

Maybe -- especially if values are likely to remain flat, decline or increase minimally. But consider this scenario over an extended period, say eight to 10 years. Assume your house increases in value by $250,000 -- 50% -- and is worth $750,000 when you want to terminate the agreement and sell. You've had full use of the $50,000 during the years without paying a dollar of interest. Now you must pay back the $50,000 plus 50% of the appreciation -- $125,000 -- to the investor from the proceeds of the house sale.

That may suit you just fine. Ignoring selling expenses and any existing mortgage debt, you net $575,000 because you owe $175,000 to the investor ($50,000 plus $125,000). For a $50,000 cash advance, you've given up $125,000. Your house rose in value by 50%, but look at the investor's return: The $50,000 advance has leveraged $125,000 -- well over double.

This may not be "interest" in the terminology preferred by the investors, but it's definitely a "yield" on their capital -- and a good one at that. The investors' return on a relatively small advance of money is magnified over extended periods of time because it's tied to the value changes of a far larger asset -- the entire house.