Money

5 Do’s and Don’ts of Home Equity

Story Highlights

  • No.1 - Renovating the house
  • No.2 - Consolidating debt
  • No.3 - For investment purposes
  • No.4 - Paying for children’s education
  • No.5 - An emergency fund

Is there a right time to use your home equity and more importantly, when should you use your home equity?

This is a question that many homeowners want to have answered but they have been warned by many people that it would be the worst financial decision that they can ever make.

As with everything, there are advantages and disadvantages of the situation and they should be weighed up. The most important thing is that the homeowner should be 100% responsible when doing this and not lose sight of their goal.

Here are a few do’s and don’ts of using home equity:

No.1 – Renovating the house

One of the most common reasons for using home equity is because homeowners want to renovate their home.

There are a few benefits to this decision. Not only does it add value to the house, but it also puts the homeowner in a position where they will be able to change certain aspects of the house that they might not have liked when they moved in.

It is a very attractive option if the house’s value has had time to appreciate and the homeowner has a bit of equity built up.

No.2 – Consolidating debt

This is an absolute no-no.

Many homeowners use their home equity to pay off their cars, their credit cards, or other debt that they have made. You cannot pay off your debt by making more debt.

Interest rates on credit cards are generally higher than on bond repayments, so from a financial perspective, it might look appealing.

But this money will have to be paid back and the homeowner must ensure that they will never rake up debt on their credit cards again.

No.3 – For investment purposes

Using your home’s equity for investment purposes is dependent on the investors’ confidence that the investment will be successful. This requires a lot of research from the investor in order to make sure that risks are involved in this type of investment.

Part of the research should be whether the return of the investment will be more than the amount that was put in.

The current prime interest rate is 10.5%, so in order for the investment to be financially worth it, the return has to be higher than that percentage whilst bearing in mind that interest rates are always rising.

No.4 – Paying for children’s education

Education is often seen as the most important thing in anyone’s life because no one can take it away from you, but that does mean that you should necessarily use home equity to further the studies of your children?

Interest rates on student loans start at a prime and continue to rise. In some cases, the interest charged on a home loan as opposed to a student loan might be lower but this could delay the homeowner’s retirement plan.

And, FYI – studies have shown that children are better off being financially secure if their parents are financially secure.

No.5 – An emergency fund

This is a possible reason for homeowners to use their equity: if the homeowner is in desperate need home equity can be used as an emergency fund, but they should remember at some stage, the money will have to be paid back.

It should only be used in an emergency if the homeowner has no other choice.

In an ideal world, homeowners should be putting away money in an emergency fund every month in order to cover the bases when things do go wrong. This way they won’t ever have to consider their home equity.

Homeowners should first consult with a financial advisor if they have any doubts regarding the use of their home equity.

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