The do's and don'ts of home equity

Is there ever a good time to use your home equity? 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. Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa, says that while it is not always a wise decision to take equity out of the bond, there are a few circumstances where is can actually benefit the homeowner.

He notes that if a homeowner does decide to use their home equity, it should be utilised in a way that will put the homeowner in a better financial position than they were in previously. “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. 

According to Goslett there are a few common situations in which homeowner choose to use their home equity. While 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 future plans.

Renovating the home

Yes – One of the most common reasons that homeowners withdraw equity is to renovate and improve their property. Goslett says that there are a number of benefits to using home equity for renovation. Apart from the fact that it will add to the home’s marketability when it comes time to sell, it gives the homeowner the opportunity to change aspects about the home that they may not have liked when they initially moved in. “The homeowner can update areas of the home such as the kitchen and bathrooms to give the home a more contemporary look and feel or they could build on a much needed extra bedroom. This will add to the occupants living experience in the home and improve the home’s value,” says 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.”

Renovation is a very attractive option if the property has appreciated in value a lot and the homeowner has substantial equity built up. “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

It depends – With investment there is always an element of risk so 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 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. 

He adds that another popular use for home equity is for the homeowner to start their own business or further their 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 

Possibly – Interest rates on student loans start at prime and go upwards depending on 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,” says Goslett. “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 

Perhaps – 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. Goslett says that home equity should only be used as an emergency fund if the homeowner has no other available options. “Ideally homeowners should put aside money each month to build up a contingency fund, so they do not find themselves in a situation where they have to use their equity for an emergency,” advises Goslett. 

Consolidating debt 

No – 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 more worse off in the future.  “Interest rates on credit card debt and personal loans are generally 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,” 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. “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.