Drawing from your home loan. Penny Wise or Pound Foolish
It can be tempting to access funds in your home loan, refinance or extend your home loan when you need the money to make a big purchase. Luxury vehicles, boats, new furniture, and expensive cruises or vacations are typical large purchases that homeowners may use as excuses to increase a home loan when interest rates are low or they need quick access to cash.
The problem with doing this is that these purchases quickly depreciate in value – your debt increases, but your assets do not. Instead of building wealth, repeated cash-out’s has a negative effect on your personal net worth.
Taking an advance on your home loan or refinancing can indeed be prudent – and even beneficial – to your financial future if done for the right reasons. Unfortunately, there are several occasions when it is not.
Accessing Advance for the Wrong Reasons
Cash-Out for New Purchases such as Cars, Holidays, Furniture or School Fees are a really bad idea.
Consider a couple that bought a home five years ago for R150, 000.00 with a R112, 500.00 30-year home loan at 6%. Today their home is worth R160, 000.00 and they owe R104, 686.00 on the home loan. They qualify to access cash on their home loan. Since the cash is available immediately– and they really want some new furniture and a flat screen television – they decide to go ahead, and add the amount to their loan to keep their payments low.
There are few scenarios available for our couple.
An example of an access facility:
It is important to understand the difference between an access bond and a re-advance on your home loan, an access bond allows you to access any additional or lump sum funds paid into your bond. This means any funds paid into the bond, over and above your monthly installment, you can access almost immediately.
If the required monthly repayment on your home loan is R700.00 and you pay in R1 000.00 a month over a period of one year; you will have paid an extra R3 600.00 over the year. This can be withdrawn either as a once-off amount of R3 000.00 or in portions with a minimum withdrawal of R1 000.
Our couple does not qualify for this option as no additional funds were paid to the home loan account.
An example of a re-advance:
Refers to available funds that you can apply for. This is usually the difference between your current outstanding bond amount and the initial registered bond amount. In this scenario, our couple would qualify for a re-advance of the R7 000.00 difference. However, you must bear in mind that a re-advance unlike an access bond facility is subject to credit approval.
n example of a further loan:
A further loan involves registering a second bond over your property, under one of the following conditions: Your property has increased in value since the original loan was granted.
Your property had surplus value at the time of original registration. The further loan is being taken out to improve your property.
This would not be a suitable option for the couple as the market value has only increased by R10 000.00.
A re-advance and further loan option may cost you significantly more in interest and fees as you may find yourself stretching out your debt by increasing the loan term for repayment of a lower installment.
The problem with these scenarios are that this couple is unlikely to ever pay off their home loan. Years after buying the house, they still have 30 years of home loan payments to make, and instead of using low rates to their advantage, they simply get deeper into debt. Their house value is not appreciating as quickly as their debt, and carrying the home loan requires both of their incomes.
If they have to sell the house quickly, they may not make enough to pay off the home loan. If they decide to have a family, they may not be able to afford to have one parent stay home, and may struggle to meet day care and home loan payments. Plus, by increasing and repeatedly extending the loan, even though they are reducing the interest rate they pay on goods, they will end up paying more in interest in the long run.
Accessing Advance for the Right Reasons
Accessing additional funds at a lower rate makes good financial sense, but sometimes getting cash at a lower rate leads people to borrow more money for things they don’t need. It is all too easy to fall into the trap of repeat use of available funds, resulting in a larger home loan, paying more interest overall, and pushing your bond free date far into the future.
Before you sign on the dotted line to increase or prolong your home loan, consider the following:
Why are you accessing funds?
If adding extra funds to your home loan, what will the money be used for? Does it have a positive or negative effect on your net worth?
What will this do to your long-term financial goals?
How many years does this add to your home loan?
What are the costs to refinance, including all application and set up fees, appraisal, and legal fees?
How long will it take to recoup your costs? Will you remain in the house for at least that long?
Knowing when, why, and how to refinance your home or to access the available funds is key to making a good decision to improve your financial situation.
Good Reasons to access Home Loan Funds
Some situations do warrant using additional funds. Some homeowners use the funds to renovate and increase property value, or to improve their education, buy an investment property and increase their income.
Others use access to funds to ultimately increase their net worth and reduce debilitating credit card payments by consolidating high interest rate debt into a lower interest rate home loan. However, this tactic can be dangerous as it makes what was unsecured debt secured by your property, which means the inability to pay it could result in the loss of your home.
When done correctly, a cash advance or renegotiated home loan can save families money on long-term interest, but accessing funds frequently without considering the long-term costs is an expensive mistake.
When you apply for refinancing, your home will be revalued and your credit history and affordability for the additional finance will be reviewed. Once these assessments meet with the lender’s approval, the application will be approved. If you, the home owner are borrowing a portion of the original home loan or accessing funds registered for future use, the funds will be made available immediately after approval. Should the lender be required to register a second bond, the funds will be payable after the bond is registered at the deeds office, which could take up to six weeks.
Costs included in the refinancing deal will be for the second bond registration, VAT and the deeds office levy. For a further loan of R1 000 000 home loan the legal cost to register a second bond would be R22 869, 50, which needs to be weighed against the refinancing benefit.
Shaun Rademeyer, MultiNET CEO says, “We offer free advice on the questions homeowners typically have about the financial implications and costs associated with refinancing their homes. We can also negotiate more favorable rates for our clients as their loan-to-value ratio improves – in most cases this is preferable to switching and incurring unnecessary costs.”
MultiNET the only independent South African bond originator offers a range of home loan calculators to help you to determine what you can afford.
If you decide to refinance your home, it’s important that you do it through a reputable company. They will be able to offer you the best advice, handle all the admin associated with processing the application and will negotiate with the bank to secure the best possible interest rate on your behalf.