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Home equity - is there a right time to use it?

It might be an extremely tempting option for homeowners with equity in their bond account to withdraw some of that wealth and use it for more immediate needs or wants. 

According to Adrian Goslett, CEO of RE/MAX of Southern Africa, while this may not always be the best idea, there are certain situations where this can actually benefit the homeowner.
 
“When is comes to a homeowner using their home equity, the important thing is responsible borrowing and only using it when it can put the homeowner in a better financial position than they were in before. The homeowner needs to carefully assess the situation and determine whether the decision could impede them financially or add to their future financial well-being,” advises Goslett.
 
He notes that with that in mind, there are a few common scenarios in which homeowners use their home equity. Some options may make sense, while others will not – the decision will largely be based on the homeowner’s circumstances and future plans.
 
Renovation - yes

Goslett says that the most common reason that most homeowners choose to use their home equity is to renovate or upgrade their property. “The benefit for a homeowner to use their home equity for renovation purposes is fairly clear, especially if the home wasn’t exactly how the homeowners wanted it when they initially purchased it. This could provide the homeowner with the opportunity to upgrade the kitchen or bathrooms, add on another bedroom or garage or just update finishes - all of which could add to the home’s value,” says Goslett. However he warns that renovations should be thoroughly planned and researched to ensure they do in fact add value to the property.
 
He notes the option is particularly attractive if the property has appreciated in value and the homeowner has a larger equity cushion. “The equity can be leveraged at the current reasonably low interest rate to make all the necessary improvements to the home. If the homeowner is able to make use of the equity without severely increasing their monthly overheads or pushing themselves out of their affordability levels, renovation is a good reason,” advises Goslett. 
 
For investment – possibly

When it comes to investment, there is always a certain level of risk involved, however it might be a feasible option to use home equity for investment purposes if it results in a higher return than the interest being charged on the borrowed money. “If the bond is financed at the current prime interest rate of 9.25%, the investment that the equity is used for will need to yield a higher return than that for it to be a viable option that makes financial sense. It is important to bear in mind that if the bond is linking to prime, any fluctuations in the interest rate will have an impact on the investment’s practicality,” explains Goslett.
 
He notes that another use for home equity is for the homeowner to start their own business or further their education. In these situations it is advisable to consult with an objective financial advisor who can ensure that the homeowner is making a sound financial decision.
 
Children’s education or student loan - possibly

The fact that home equity can often be financed at a lower rate and could provide a higher loan amount makes it a tempting option for financing tertiary education. However, this option is not without its risk.
 
“Depending on the parent’s financial well-being and their age, they could end up delaying their retirement due to having a large bond to pay off. If the extra financial pressure becomes too much they can also risk the possibility of losing their home. It is very important that parents do not sacrifice their own financially well-being, as studies show that children are better off with financially secure parents than being financially secure themselves and having to look after their parents,” says Goslett.
 
Emergency fund – possibly

While home equity could offer an alternative to an emergency fund in a low interest-bearing savings account, it is still money that will need to be paid back. “If there is an emergency and the homeowner uses their home equity but then loses their income, they risk losing their property,” explains Goslett. “It might be the only option if the homeowner does not have savings put aside for emergency purposes, however having a contingency plan and savings will always be a far safer option for the homeowner,” he advises.
 
Paying off credit cards and debt - no

Another extremely popular use for home equity is paying off credit cards, car loans and other personal debt. While this could initially give the homeowner some more disposable income, the ease at which new debt can be obtained suggests that this option could result in the homeowners being financially overstretched in the future.
 
“When it comes to the numbers, using the home equity to dissolve credit card debt will make sense, however it won’t take away the reason why the debt occurred in the first place. If a homeowner decides to do this, they will need to ensure that they no longer want to use a credit card or they risk being in the same position in the future. Freeing up unsecured debt for secured debt is generally not a good idea,” advises Goslett.
 
He notes that homeowners who are thinking of using their home equity should consult with a financial adviser if they have any doubts or would like an objective opinion. “It is important that the decision is one that places the homeowner in a financially beneficial position without resulting in negative consequences down the road,” Goslett concludes.


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