Considering home equity to pay off debt? Here's what you need to know

Considering home equity to pay off debt? Here's what you need to know

Many homeowners consider tapping into their home loan equity to settle other, higher-interest debts. While this can be a financially savvy move in certain circumstances, it also carries significant risks. The key to making a smart decision lies in understanding when and how to use home equity effectively.

The recent interest rate cut could further entice homeowners' decision to access the equity in their home loan to pay off other debts. Even without the recent cut, loans such as credit card balances and car finance typically come with much higher interest rates than home loans. Now with the lower interest rate, the gap between the cost of servicing home loan debt and other high-interest debt, such as credit cards or car loans, widens. This might make tapping into home equity seem even more attractive as the potential savings on monthly payments grow.

However, before leveraging your home equity to settle these debts, we remind homeowners to consider that if you fall behind on your home loan repayments due to this decision, you run the risk of losing the property.

When homeowners use the access bond facility to cover substantial expenses like a vehicle purchase, they need to be mindful that, while the interest on a home loan is lower, the repayment term could be significantly longer. If you are early into your bond term, you could end up paying more in interest over the lifetime of the loan.

Unless your bond is nearing the end of its term, using it to pay off a shorter-term debt like a car loan could extend the repayment period, resulting in higher total interest costs. If you do decide to go ahead, then be sure to pay back the loan amount over five years rather than ten or twenty years.

Ultimately, tapping into home equity to pay off debt is a major financial decision that should not be taken lightly. Homeowners are advised to consult with a financial advisor to assess whether this is the right strategy for their individual circumstances.

Acts as a Source of Wealth and Financial Security

Home equity is a form of forced savings. As you pay off your bond, you're essentially transferring your cash into home value, thereby helping you build wealth over time. For many, home equity is their largest financial asset, providing significant security in retirement or in times of financial need. Unlike many other investments, home equity is a tangible asset that can also increase in value over time, making it a key part of a long-term financial plan.

Access to Borrowing Options with Lower Interest Rates

One of the biggest advantages of home equity is that it can be used as collateral for loans. This affords you various borrowing options, often at lower interest rates than unsecured loans and can provide funds for larger expenses, but it's important to borrow responsibly since these loans are secured by your home, meaning failure to repay could put your property at risk.

Helps with Retirement Planning

Home equity can be especially valuable in retirement planning. Some homeowners downsize by selling their property, buying a less expensive home, and using the proceeds for retirement income. Others may explore options like a reverse mortgage (home equity release loan), allowing them to access their equity without having to move. Home equity can be a reliable source of funds for those who wish to maintain a comfortable lifestyle during retirement without dipping into other investments.

Extract from Property 24