“Home loan lending totalled some R10bn monthly in 2011,” notes Rudi Botha, CEO of leading mortgage originator BetterBond, “and fully 25% of that - or R2,5bn a month - was for further advances on existing bonds – or what are called equity loans in the US.
“Such loans are basically a way for existing homeowners to access the value (equity) that they have built up in their home over time, either by deliberately paying down their home loan or waiting long enough for the value of the property to substantially exceed the original loan amount.”
And, he says, by far the most common reason for doing this at the moment is to “consolidate debt” – or rather, to replace the debts that carry higher interest rate charges with the further advance, on which the bank will charge a relatively low rate of interest.
“There are of course many reasons that one might want a further advance, such as a family medical emergency or university fees for a child, but by far the majority of applications we see for this type of loan at the moment are for debt consolidation, followed by home improvement projects.”
Which is not necessarily a bad thing. However, says Botha, there are some big potential problems with such loans and homeowners need to treat them with great caution. “The biggest problem is that most people who take out further advances for debt consolidation don’t change their overspending habits and before long, find themselves in deeper credit trouble than before. Now they have a bigger home loan plus a new credit card balance to pay off.
“Indeed, taking out a further advance for debt consolidation is really only a positive money move if people have already demonstrated a serious commitment to debt reduction.”
In addition, he says, those taking out further advances often don’t realise that they may be putting their biggest asset at risk. “If you default on other debts your car may be repossessed or you may have a judgement taken against you, but if for some reason you are unable to pay the instalments on your increased home loan, you could easily lose your home.”
Fortunately, says Botha, most banks will now only consider further advances up to 80% of the home’s value, so there is not as much danger of homeowners ending up in a negative equity situation as before. This occurs when property values fall and owners find that they owe more on their homes than they are worth. “Still, though, a large further advance can make it difficult to sell your home for a profit if something happens in your life like a transfer or a retrenchment and you need to move fast.”
And finally, he says, homeowners need to realise that taking a further advance will in most instances put them back to day one on a 20-year home loan that they have already been paying off for many years. “What is more, you could well end up paying off the new loan at a higher interest rate than that applied to your old loan. For example, a borrower that took out a bond five years ago might possibly have got a rate of prime minus 2% on a R1m loan. But if he or she now takes out a further loan of R300 000, the total ‘new’ loan of R1,3m could then be re-priced closer to the prime lending rate of 9%, depending on the type of client.
“The reason for this is that the banks are now paying much more for the capital to fund these loans and it is important for them to try and rectify their margins in their home loan businesses.
“In any case, it makes it all the more important for consumers to make sure they really put the extra money obtained from a further loan to good use to repay high interest debt, and then pay more than their minimum home loan repayment every month in order to reduce the principal debt as soon as possible. Once again, what we are talking about here is determined and steadfast action to get rid of all debt, not just the high-interest items.”