Fragile economy: Five reasons not to spend your equity
With interest rates on an “upward trend”, homeowners are once more being encouraged by all and sundry to use the equity they have in their homes to pay off or reduce higher-interest rate debt such as car finance, credit card balances and personal loans.
This would be fine if the economy was robust and home prices were rising fast. As it is, however, the economy is fragile and the rate of home price growth has been slowing down for several months, so a much more conservative approach is indicated.
Tempting as it may be to “consolidate” all your debt into your home loan, we need to remember what happened to homeowners who did this when interest rates began rising just before the global economic crisis in 2008.
As property values slumped following that crisis, many of these owners ended up owing more on their homes than those properties were worth – and had to “pay in” if they wanted or needed to sell them.
Now I’m not expecting that scenario to repeat itself, but there’s also another very good reason for not using your home equity in this way. This is that you will be turning short-term debt into long-term debt - and will need tremendous discipline to increase your monthly home loan repayments.
Indeed, I have often seen that what happens when homeowners do this, they actually go right out and incur more short-term debt instead of using any extra cash they have to pay down their home loan as soon as possible.
Then there’s the third reason to keep your home equity intact – and in fact increase it whenever possible – and that is that you might need it for a genuine emergency. Most people are not able to save much these days, and it can be very useful to have equity in hand if you face a sudden medical or other family crisis.
Fourth, it is also most useful to have equity in your existing home if you are thinking of selling and moving to another property. It will be much easier to get a loan for the new home if you have a deposit, and your equity can provide this. And of course the bigger the deposit, the lower your repayments will be on the new loan.
And that brings me to the final reason for preserving your home equity now, which is that you need to be prepared for the possibility that interest rates could start to rise more rapidly than expected.
Equity (and thus a smaller home loan balance) is what cushions you against the impact of such increases, and lowers the risk of you losing your home because you can’t make the monthly bond repayment.
Photo courtesy of www.wikihow.com
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