Beware of falling into equity traps
Borrowing against your home to fund investments needs careful consideration, Ben Hyde reports.
USING equity in property to buy investments can be a ticket to lifelong wealth but experts say you need to be wary of the traps. In the best-case scenario, leveraging off property can help build a substantial investment portfolio.
On the other hand, it also could leave you without a house at all.
Property lecturer, investor and author Peter Koulizos says investors should err on the side of caution to avoid risking losing the family home.
‘‘If you use too much equity on your own home, you leave yourself in a dangerous position. Let’s say you borrow 97 per cent of the value of the property – hard to do now but you could five years ago – and the value falls 5 per cent. You then own less than what you owe,’’ he says.
‘‘The best way to mitigate the risk is to not use too much equity.’’
Mr Koulizos says investors should avoid digging into their equity to finance a depreciating asset.
‘‘Using equity in your home to go on an overseas holiday or to buy a new car is how you get into difficult a position,’’ he says.
‘‘The holiday is not worth anything except memories and a one-year-old car or boat is worth less than when you paid for it.
‘‘But using the equity in your home to buy appreciating assets, like other properties, is very smart.’’
To minimise the risks, Mr Koulizos recommends those using equity to buy an investment property to keep some cash on hand.
‘‘Then you can sleep well at night knowing if your property is vacant for a month, or if it needs renovations, you can cover it,’’ he says. BankSA general manager Chris Ward says there are several elements to consider before using equity in your home for investment.
‘‘It’s important to make sure the level of gearing is conservative and that you build in a buffer in your calculations to ensure your investment strategy is robust enough to ride through fluctuations,’’ he says.
Mr Ward says it is important to ensure life insurance is up to date and that any holding costs are factored into the household budget.
Police Credit Union executive manager of product and marketing Paul Modra says parents also need to be wary of using equity in their home as a guarantee for their children’s property purchases.
‘‘The major risks involved with going guarantor for someone else’s loan is potentially losing your own property if the other person defaults on the loan,’’ he says.
‘‘Guarantors can risk being financially out of pocket to protect their property by being forced to make the other person’s repayments to stave off surrendering their asset.
‘‘Limit the risk by only allowing a percentage of your house as collateral, maybe a maximum 20 per cent of the funds required for the loan.’’