Among the opportunities provided by what has been termed ‘the real estate boom’ has been increased wealth in home equity. Equity is simply the difference between the market value of a property, and the outstanding debt (if any).
Homeowners, some of whom have only owned their homes for as little three to five years, have fast accumulated new worth in their equity in their homes. For example, consider the homeowner who acquired a mortgage facility in March 2003 for the sum of $765,000.00 to purchase a townhouse in East Trinidad. The same property was valued in December 2005 (less than 3 years later) for $1.25 million, theoretically providing this homeowner with equity of at least half a million dollars.It stands to reason therefore that the level of home equity that is currently being enjoyed by homeowners in the traditional up-market areas, whose mortgage loans have been repaid by as much as fifty percent or more hold significant wealth in terms of their equity in the existing property. Bear in mind however, that this equity only translates into cash, if the homeowner decides to sell the house.
In these times of relatively high real estate prices, coupled with the fairly competitive interest rates, it is important is evaluating your financial position to consider “How can I make my home equity work for me?”
Facilities are provided to increase the debt on the property based on current market value as opposed to the original cost that may have been the basis for funding upon purchase or construction. Referred to as a home equity loan, access to this facility is dependent on the homeowner’s current needs and existing financial circumstances. A home equity loan is generally secured by way of a second mortgage on the property. However, depending on the interest rate and/or outstanding repayment term of the existing mortgage, the homeowner may opt to refinance the existing balance and add an additional amount to the total outstanding debt.
As far as possible, home equity financing should be utilized to improve long-term wealth. For this reason, it is most often utilized to improve the value of the property or the long-term financial circumstances of the customer. Investments of such funds are geared towards creating further wealth. Such investments may include:
Home Improvement
There are those who may argue that this is only purpose for which a home equity loan should be obtained. This is on the premise however, that the loan is to undertake a project, as opposed to general home repair, that will enhance the value of the property by an amount that will exceed the cost of making the improvement(s). Such projects may include adding a swimming pool, installing an electronic gate, or enclosing the property with fencing. Because of the amount by which these projects may increase the market value of the property, they may serve to increase the home equity by, in some case as much as twice the cost of actually undertaking the project.
Long–term investment
Where the rate of return on a low risk, long term investment such as an annuity, is higher than the cost of incremental funds on a mortgage facility, such investments may financed by an equity loan on a property. High risk investments such as stocks and shares are not advised. The important factor to consider when deciding on home equity financing for investment purposes, is whether the rate of return on the proposed investment is higher than the rate of interest being paid on the mortgage loan with similar risk and preservation of capital, that is, the amount originally invested. Fluctuating investments should be avoided.
Long term investment options could also include the purchase of a property for rental purposes.
Debt Consolidation
This may be the most common purpose for which home equity loans are considered, and has become a significant marketing strategy for many mortgage financiers. While it is preferable that home equity be used to generate wealth and increase one’s asset base, the decision to use home equity for the purpose of debt consolidation makes sense where high cost debt like credit cards is repaid, allowing for improved cash flows to allow for savings.
Education and Medical Expenses
Any significant expense that is unplanned and cannot, in the normal course be facilitated by regular savings, can be accommodated by equity financing. Such facilities allow for immediate funding of the expense with ample time for repayment over an extended period, lessening the impact on disposable income. The return on this investment however, is more long term in nature in that having achieved the objective, the results/returns may not be immediately forthcoming.
Home equity loans should at no time, be used for what can be described as a ‘luxury purchase’ such as a vacation trip to Germany! In such cases, the debt continues long after the ‘returns’ are done. Long term debt should be used to fund long term assets and/or long term needs. With regard to expenses such as for medical or other family emergencies, such decisions would have to be determined on a case by case basis.
A home is usually the most significant asset that is acquired by an individual, and it is one which, in times of increasing real estate prices, can be a source of further wealth creation. The homeowner must be careful however not to do anything that would put the initial or the additional investment at risk. While the process may appear easy, it must also be significantly rewarding.
By: Gillian C. Caesar,General Manager, Mortgage Services
Trinidad and Tobago Mortgage Finance Company Limited