The do's and don'ts of home equity

Especially as a result of the financial constraints most households face as a result of the measures put in place to curb the spread of COVID-19, many homeowners who have equity available in the bond accounts might be tempted to withdraw some of the money and use it for more immediate needs or wants.

According to Regional Director and CEO of RE/MAX of Southern Africa, Adrian Goslett, while it is not always a wise decision to take equity out of the bond, there are a few circumstances where it can benefit the homeowner. “Some reasons for using the equity make good financial sense, others don’t – the decision will largely be based on the homeowner’s circumstances and plans,” he explains.

Below are a few of the reasons why homeowners might be tempted to dip into their home equity along with advice from RE/MAX of Southern Africa on whether this might be a good idea.

An emergency fund

If the homeowner is in dire need, home equity can be used in an emergency. However, it is important to remember that at some stage it will need to be paid back. Home equity should only be used as an emergency fund if the homeowner has no other available options. 

Paying off other debts

Many homeowners opt to use their home equity to pay off credit cards, car loans and other forms of personal debt. This option will provide the homeowner with additional disposable cash initially, but if they obtain new debt, they will be far worse off in the future. Interest rates on credit card debt and personal loans are higher than bond interest rates, so it will make financial sense from that perspective. However, if the homeowner does do this, they will have to ensure that they don’t continue to use credit cards and take out further debt.

Renovating the home

One of the most common reasons that homeowners withdraw equity is to renovate and improve their property. There are benefits to using home equity for renovation. It will add to the home’s marketability when it comes time to sell, and it gives the homeowner the opportunity to change aspects of the home that they may not have liked when they initially moved in. The homeowner can give the home a more contemporary look and feel or they could build on a much-needed extra bedroom. It will add to the occupants living experience in the home and improve the home’s value.

“As a rule of thumb, renovations can often be a good reason to use the equity, provided the homeowner can make use of it without severely increasing their monthly overheads or pushing themselves out of their affordability levels,” says Goslett. 

For investment purposes

With investments, there is always an element of risk. Using home equity to fund an investment depends on whether the homeowner has done their research and is confident that the degree of risk is worth the potential return. Part of the research a homeowner should do is whether the return on the investment is going to be greater than the interest charged on the borrowed money. The current prime interest rate is 7.75%. For the investment to make financial sense, the return will need to exceed that percentage.

Another popular use for home equity is to start a business or further education. In scenarios such as these, it would be advisable to consult with an objective financial advisor who can provide guidance and advice regarding these options. 

Pay for children’s education

Interest rates on student loans start at prime and go upwards depending on the credit profile and level of affordability. In some cases, the interest charged on the home equity would be lower, and the loan amount could be higher. While using home equity to finance your children’s education is a tempting option, it does have its risks.

The feasibility of this option largely depends on the parent’s age and financial well-being. 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 better off with financially secure parents than being financially secure themselves and having to look after their parents.

In all instances, RE/MAX recommends 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. “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.

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