Watching a home's value> plunge by double-digit percentages in a matter of months is enough to unnerve even the most financially secure homeowner. And, as the real estate market continues to reel concerns are growing that the free fall is far from over.
Playing into that anxiety are two companies EquityLock Financial, based in Austin, Texas, and Lighthouse Group based in Charlotte, N.C. that are selling products promising to put a little more control in homeowners hands. Their pitch? That homeowners could spend a little now to hedge against declines in the value of their home later.
Here's how it works: For a fee of 1% to 3% of their home s value, homeowners buy a contract that protects them against the loss of equity in their home if the market takes a turn for the worse. The contract, which should not be confused with an insurance policy, pays the homeowner when he sells his home in a market where average home prices have dropped since their purchase. The amount he receives is tied to the size of the market s decline, as measured by one of two home price indexes (both of which are based on sales of single-family homes).
Say you buy a home in Denver for $300,000. Five years later, after Denver's home price index falls 10%, you sell it for $290,000. At closing, the company you bought the equity protection from pays you $30,000 your original purchase price times 10%. Even if you sold your home for more than what you paid to buy it, you can still make the claim as long as the index fell. (If the index rises, however, you can t make a claim and you're out the $6,000 you spent buying the contract.)
It s the kind of product that ends up being useful for a niche part of the population, but likely not really worthwhile for homeowners in general, says Todd Sinai, associate professor of real estate at the Wharton School.
One factor to consider is how long you plan to live in your home. If it s going to be 10 or 15 years, buying protection doesn't make much sense, says Susan Wachter, real estate professor at Wharton. While home prices can change dramatically in the short term, they hold steady and increase over longer periods. For short-term homeowners, though, it might make more sense. If, for instance, you anticipate a move for work and worry that area prices will sag, the protection can be worthwhile, says Sinai.
We spoke with real estate experts about what to look out for when shopping for home equity protection plans. Here's what they had to say:
Calculate the costs
Payment terms are different for each product. EquityLock s premium, which is paid upfront, ranges from 1% to 3% of the purchase price (or of the current value if you already own a home). Lighthouse s premium could be paid either on a monthly or yearly basis, and typically works out to just under 1% of the home s value, per year, says a company spokesman.
Say your house is worth $300,000 and you pay $6,000 (a 2% premium) for EquityLock s protection. You re starting with a $6,000 loss, and you ll only break even if the house index drops enough from the time you purchase the home to the time you decide to sell. You really have to think hard if the initial cost is worth it, says Sinai.
Watch out for lockout periods
Be sure to ask about any lockout period which bars you from collecting payment before a set time. EquityLock imposes an exclusion term ranging from 18 to 30 months from the time the protection is purchased. So you can t sell your home and make a claim a year after the contract begins. Lighthouse has no lockout period. But if a homeowner exercises the contract after, say, the first month, they still owe the future monthly payments that are due.
Housing indexes are imperfect
Potential payouts are tied to a house price index: either the S&P Case-Shiller house price index, which tracks 20 metro markets, or the Federal Housing Finance Agency s House Price Index, commonly known as FHFA HPI, which covers 386 markets. The problem? Indexes don t capture the true volatility and variation within markets and don t always correlate with the specific value of your home, says Jonathan Adams, a finance professor at NYU. For example, if highway construction has just gotten underway at the next block over, chances are your home s value would dive but the index might stay the same, says Adams. (Lighthouse says tying the contract to an index is the most efficient way to determine a home s value, without having to actually sell the house or get an appraisal.)
Be wary of new, untested products
Bear in mind the novelty of these plans when assessing their worth. When it comes to finances and your home equity, you really want to go with someone who has a history, says Alison Southwick, spokeswoman for the Better Business Bureau. Also, new products tend to be more expensive, says Mark Browne, professor of risk management at the University of Wisconsin. They haven t been around for long, so it might be better to wait for competition to build.