Unlocking your home equity for a home renovation or two can be a profitable investment… just don’t go splurging it on shopping sprees and unsettled bills.
According to Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa, taking equity out of your bond account can be beneficial to homeowners in certain instances, but it can also be the wrong financial move to make if used for the wrong reasons.
Home equity should always be utilised with the intention to better your current financial standing. “The crux of the matter is that the homeowner needs to be responsible with their borrowing and determine whether taking the equity will advance them or impede them financially,” advises Goslett.
There are a host of common reasons why homeowners consider tapping into their home equity, but determining the right time and cause to cash in on your property is vital:
Home renovations: Yes
Home renovations and improvements are a common reason for many homeowners who decide to withdraw equity. Areas like the kitchen and bathrooms always have room for improvements and can easily be updated to give your home a more contemporary look and feel, which will bring out the best in your living experience and of course add extra value to your home.
Using home equity on property renovations can be beneficial to your home’s marketability when opting to sell. It is also valuable to the homeowner in affording them the opportunity to change aspects about the home that they may not have initially liked when moving in.
According to Goslett, “When deciding to renovate it is important not to overcapitalise and to ensure that the planned project will in fact add to the perceived value of the home.” Renovations become an appealing option in instances where the property’s appreciation has increased in value and has accumulated a substantial amount of equity. “It is a good reason to use the equity, provided the homeowner is able to make use of it without severely increasing their monthly overheads or pushing themselves out of their affordability levels. Careful consideration needs to be given to the fact that interest rates are in a hiking cycle,” advises Goslett.
For investment purposes: Maybe
Opportunities to invest are always present and generally, if it makes more money than it costs, then it can be considered a good investment. There are however, always risk factors present with any type of investment, which is why using your home equity to fund it may not always be the brightest idea. Conducting enough research before doing so, will be beneficial in ensuring that the risk is worth the potential return. Considering whether the return on the investment will be higher than the interest charged on the borrowed money is important to weigh up before tapping into your home equity.
“The current prime interest rate is 10.50%. In order for the investment to make financial sense, the return on the said investment will need to exceed that percentage, bearing in mind that interest rates are expected to continue to rise,” explains Goslett.
Growing a business venture or furthering your education is another popular reason why many homeowners decide to borrow from their home equity. Although it may sound like it’s for a great cause and for the betterment of your future, it is still important to consult with a financial advisor before making any hasty decisions.
Pay for children’s education: Maybe
Paying for a child's education with your home equity may seem like a no-brainer for most parents, but there are just as many risks to be aware of as with any other form of borrowing. Getting through college in most instances requires the help of financial aid, but home equity loans may be not always be the ticket to getting a degree. Being able to afford this option is largely dependent on the parent’s age and how financially well-off they are. Interest rates on student loans increase according to one’s credit profile and level of affordability and are never stagnant. In some cases, the interest charged on the home equity would be lower and the loan amount could be higher.
“Taking equity out of the bond could delay the homeowner’s retirement, or worse put them in a financial position where they could risk losing their property. In these instances, it is best not to take the money from the home equity. According to studies, children are generally better off with financially secure parents than being financially secure themselves and having to look after their parents.”
An emergency fund: Maybe
Most homeowners turn to their home equity as a credit lifeline in the event of an emergency situation. Although this may seem like the ideal backup plan to have, it’s not a complete foolproof option to rely on. Using your home equity to fund a home emergency situation should only be considered if the homeowner has no other options available, but it’s important to remember it still needs to be paid back. Ideally, homeowners should build an emergency fund off their own savings by putting money aside each month in growing their own contingency fund.
Consolidating debt: No
Interest rates on credit card debt and personal loans are generally higher than bond interest rates, which is why most homeowners consider consolidating debt as a sensible decision to make. Deciding to do this may trick you into thinking you’ve done something about it, when in actual fact it’s still there. And the habits that landed you in debt probably haven’t disappeared either, which is why it’s never advisable for homeowners to use their home equity to pay off debt, like credit cards, car loans and clothing accounts. Taking this route can offer you the initial cash to pay off everything owed, but it isn’t a successful choice if the various habits contributing to your debt continues and leaves you in a worse off financial position.
For homeowners who are considering the option of using their home equity, it is important to weigh up your options and be mindful of the pros and cons this option can offer. Obtaining financial advice from a professional advisor is always a useful idea and can help to settle any doubts you may have. “Regardless of the reason a homeowner uses their equity, the most important aspect is that the decision should be beneficial and does not hinder them financially in the future,” Goslett concludes.