If you’re like most people, a home is your most valuable asset and your bond repayment is likely to be your largest monthly expense. With so much money tied up in one item, it is important to have a plan in place to use your home to reach other financial goals.
Is it smart to take out a home equity loan for home improvements? Or to pay off your car? While there is no doubt this is a cost-efficient way to finance major purchases, it might not be a good idea in the long term. Regular withdrawals from your home loan account extend the duration of the bond repayments, which means that you pay interest for longer. How you treat your home loan depends on your particular financial situation. But smart use of the equity in your home can save or even make you money if it is done cleverly.
Need a car?
If you are in the market to buy a car and need a loan, you could save as much as 4% on interest charges if the money is borrowed from the equity in your home loan. This is because there is generally a lower interest rate on home loans than car loans, as a car is a depreciating asset and the bank carries more risk if the owner were to default on a payment.
You should pay the same instalment back into the bond as you would be paying had you financed the asset over the shorter term and at the same interest rate. This is the only way that it will be effective in interest saving. The best way for this to work is to pay the full car instalment into the bond punctually each month. You should not pay it over the entire life of the loan, however, as the interest charges will amount to a small fortune.
Get your bond paid off fast
If your goal is to have a mortgage-burning party as soon as possible, there are certain actions you can take to accomplish this goal. Salary increases should be paid into your bond or equity loans as well as any extra money left over at the end of the month. If you have been paying off credit card debt, you should shift the payment to your home loan once the cards are paid off.
Raising the excess on car and household insurance policies can cut monthly insurance premiums by up to 25%. You will have to pay interest to access the money in the short term but, in time, the premium savings will offset the interest charges should you need to access the money early. Also, if you were to take the 25% insurance premium saving and pay it into the bond, it would reduce the capital amount owing.
Need a loan?
If you need to borrow money from somewhere, home equity is the best place to obtain it. But it is important to weigh up the options.
When borrowing, if you have the option of taking from an investment portfolio rather than dipping into the home loan, you should compare the net rate of return. If an investment portfolio is providing a higher rate of return than the percentage it would cost to borrow from the home equity loan, it would be better to leave the money in the portfolio earning interest. You should not borrow money out of retirement funds as they have a stiff penalty for early withdrawals.
Home improvements
Although home improvements generally increase the value of the home, the return is not always rand for rand. The value of some improvements is subjective or depreciates in time; the next home owner might not appreciate the koi pond and the modern finishes might lose their lustre. For this reason it is recommended that you only invest in improvements if you want to sell soon.
The benefit of borrowing from a home loan for home improvements compared with other forms is the tax advantage for those who itemise their returns.
Allister Long is the managing director of Powerhouse Financial Services