I’ve got around $1,800,000 in home equity locked up in one property. The property was originally purchased for $1,520,000 at the end of 2004 with $305,000 down and a $1,217,000 mortgage. The property is now worth an estimated $2,600,000 with a remaining $800,000 mortgage at 2.375%.
Although it’s nice to have $1,800,000 of home equity (31% LTV), it’s essentially “dead money” that’s doing little to improve my net worth or lifestyle. I controlled this property when my equity was only $305,000 after the initial downpayment, so the leverage power is no longer as strong.
Because roughly 67% of the average homeowner’s wealth is trapped in home equity, being “house rich, cash poor” is a common situation. As a result, homeowners have traditionally turned to home equity lines of credit (HELOC) to extract equity to pay for life’s many expenses.
One look online and you’ll find that HELOC rates are generally 1% – 2% higher than your current mortgage rate e.g. 3.75% for a 30-year-fixed vs. 5% for a HELOC. In addition to higher interest rates, using a home like an ATM machine may get homeowners who lack discipline in trouble down the road.
If only there was a better way to extra home equity at a lower cost. Enter Patch Homes.
Patch Homes Review
When Sahil Gupta, Co-Founder of Patch Homes reached out to me to do a sponsored review, I obliged because I’ve known Sahil since my consulting days at Motif Investing. After five years at Motif, Sahil started Patch Homes with industry veteran Sundeep Ambati. They got incubated by Techstars, and this past April raised $1M in seed funding.
The San Francisco-based firm enables homeowners to extract equity at 0% interest and no monthly repayments. In exchange for 0% interest, Patch Homes shares in future appreciation or depreciation of the home’s value. Given I’ve decided not to take on more debt, I thought this was a brilliant solution that’s incredibly innovative.
After a ~68% increase in San Francisco home values since 2012, I’ve been thinking more often about about cashing out and simplifying life, especially with my last tenant situation. In retrospect, my tenants weren’t that bad. I just have a much lower threshold for inconsiderate people now that I’m more financially independent.
Unfortunately, every time I run the numbers to list my home for sale, I balk at the ridiculous amount of commissions and transfer taxes I must pay.
Here’s a cost breakdown if I sold my home for $2,600,000.
It seems absolutely absurd to spend $130,000 on commissions and $19,500 on taxes to sell my home. I’d rather use that money to take a private jet with my buddies to some remote island and reenact scenes from the movie, The Beach. Selling to extract equity is a less than optimal solution, unless the right buyer offered me much more.
Instead, if possible, why not extract all my equity ($1,800,000) via Patch Homes at a 0% rate for 10 years, pay down my $800,000 mortgage at 2.375%, and invest the remaining $1,000,000 in a 10-year, AAA-rated zero coupon bond with a yield to maturity of 3.5%? Not only would I save $19,000 in mortgage interest expense each year, I’d earn over $350,000 in interest income when the zero coupon bond expires in 10 years! Of course I’d still have to pay back the $1,800,000 I borrowed from Patch Homes as well.
This arbitrage of ~$540,000 in net worth creation over 10 years seemed like a no brainer, so I applied. Here are the three steps:
1) The first step was to input my property address and for us to agree on my home’s current value. See their eligibility guidelines for more details.
Patch Homes decided to use Zillow to estimate my home value at $3,284,000. Zillow is ~$700,000 too high in my opinion, but that’s great since a higher base means a higher hurdle before Patch Homes can share in any of the upside profit if I were to sell within 10 years.
Do note that if the estimated home value comes in below what you expect, there’s a nice adjuster you can slide to increase your home’s value in the application. You can also decrease your home’s estimated home value, but that would be a silly move.
2) The next step was to input the following information about my home: use property for (primary/rental), number of loans, mortgage type, mortgage balance, and monthly mortgage payment.
3) The final step was to answer five homeowner profile questions: job type, approximate FICO score, annual household income, cash-out amount desired, and use of funds.
The entire application process took only two minutes to get my offer below:
Darn, no $1,800,000, 0% interest loan for me! I knew my arbitrage idea was too good to be true. Instead, Patch Homes came back with a $150,000 financing amount with no payments for 10 years. Not bad given most banks would maybe give me at max a $250,000 HELOC at a 5% rate in today’s market.
Patch Homes limits the borrow to 80% Combined Loan To Value or cash-outs for up-to $200,000, which makes sense from a risk perspective because there still needs to be enough equity in the property in case a borrower decides to default. Skin in the game is what it’s all about after the financial crisis burned so many financial institutions.
Despite not being able to get $1,800,000 out, $150,000 is still a nice sum of cash which can be used to pay down $150,000 of my vacation property’s mortgage at 4.25%. If I made this move, I would save $6,375 a year in interest for 10 years = $63,750.
Below is a snapshot of what my offer means. Given I don’t plan to sell my home, sharing in the upside or the downside doesn’t really matter. However, it’s nice to know that if my home does decline in value, I get to offload $150,000 of the risk onto Patch Homes.
Let’s say my house drops in value by 20% from $3.28m to $2.62M. Here’s the math:
Total loss = $3,284,000 – $2,627,200 = $656,800
Patch Homes Share = 14.27% * 656800 = $93,725
Final Payment to Patch Homes = $150,000 – $93,725= $56,275
This is a huge benefit, especially if I believed my home was only worth $2,600,000 to begin with. By selling for $2,627,200, I actually gain $27,200 based on my expected home price AND I save $93,725 from the Patch Homes contract for a total gain of $120,925! But wait. I will have used the $150,000 to pay down a 4.25% mortgage for 10 years, so I’m also saving up to $63,750 in interest expense.
Of course, nothing is truly free since there are always costs associated with doing any type of business. I’ll have to pay a servicing fee of $4,500 (3% of $150,000), $400 in title and escrow fees, and a $540 home appraisal fee for a total cost of $5,440.
The home appraisal is a third party assessment that will be used by Patch Homes to come to a reasonable market value. Therefore, my $3,284,000 Zillow estimate may be at risk.
If I decide to pay back the 0% Patch Home offer in one year, my cost for borrowing $150,000 will really be $5,440, or 3.6%. That’s still competitive compared to taking out a HELOC at 5%+. However, if I borrow for 10 years and then pay back my 0% interest Patch financing, then the fee is 1/10th the amount or 0.36%.
Finally, and very importantly, there will be an appraisal at the end of the 10 year contract to calculate what Patch Homes pays you or earns from you based on the contract. It’s unknown whether all parties can agree on the final market price since the price of a home is only what someone is actually willing to pay for it. Any estimate is just a best guess.
A Growing Market Place
Based on my research, Patch Homes is a very innovative tool for homeowners to tap their home equity. What’s not to like about an interest free 10 year contract? Yes, you’ll have another lien on your house in addition to the primary lender. But if you plan to never sell or default, it doesn’t really matter. Further, you can still pay off your primary mortgage however quickly you like regardless of the Patch Homes contract.
For those of you who are thinking of taking the Patch Homes contract, defaulting, and escaping to Mexico, so sorry. You will unlikely get approved for the 0% interest Patch financing since you’ll either have too little equity in your home, too poor credit, or not enough income. But I guess you’ll never know unless you spend the two minutes applying.
I asked Sahil, the CEO how they plan to make money if homeowners like me never sell. The simple answer is they won’t beyond the upfront servicing fees. But according to their data, most homeowners turn their homes over every 7-8 years, hence their 10-year contract duration.
Essentially, Patch Homes is betting on the average homeownership turnover rate remaining below 10 years, an upward trend in home prices, and their ability to raise enough money to keep the company operational until the first home sales take place.
For anybody looking for a low cost way to tap into their home equity, Patch Homes looks like a good solution. I’m all for taking advantage of startup innovation to save money and grow wealth. Patch Homes is currently only operational in California. But they plan to be operational in other states such as New York and Texas by the end of the year.
If you are bearish on real estate for the next 10 years, or however long you’d like to extract your home equity for, check out what you can get from Patch Homes here. I’m curious to see what your offer is as they’ll still give you quote even if they don’t operate in your state yet.
If you’re bullish on your area’s real estate market, there are probably more cost effective ways to borrow money from your home.
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Updated for 2019 and beyond.