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Financial Friday #112: Richer or Poorer than we Think?
One of Canada’s largest banks has been telling us for years that we are richer than we think, but the average Canadian may tend to disagree these days. Spiraling prices make balancing the household budget an ongoing nightmare and higher interest rates are piling on additional costs to the 50% of Canadians who hold a variable rate mortgage.
However, there is one source of “riches” that is often underutilized and might just make us richer than we think, and that is the opportunity to leverage the equity in our home. These days, a lot of people use the equity in their home to pay for things via a line of credit, but there is a big difference between simply buying stuff and taking advantage of the the locked up value in your home to generate income or lower your debt cost.
There are plenty of good reasons to tap into your equity, just be careful that soaring home values and plenty of interested lenders don’t get in the way of sound financial decision-making. Equity-fueled annual vacations or a designer kitchen could add years to your mortgage burning day and seriously derail your retirement timeline.
It has been very easy over the last few years to fall into a cycle of endless equity borrowing as home prices have shot up and interest rates have been extremely low. However, it could become a different story quite quickly as the interest only payments on that Home Equity Line of Credit (HELOC) rise with each successive interest rate hike and home prices continue to fall. In the worst-case scenario you could lose your home, so it’s important to continuously monitor your outstanding balance, repayment ability, and the cost-benefit of anything funded with borrowed equity.
The advantage of equity is that it is a readily available source of low-cost borrowing. If you carry a credit card balance from month-to-month at 20% and could borrow on an equity line of credit at 4% and pay it back tomorrow, our only question would be, “What are you waiting for?”.
Consolidating debt and saving on interest isn’t the only play, you could also borrow against your equity at 3 or 4 per cent and use it to invest in the markets or purchase an income property… or lend it to someone else at 10%. There is a real demand from people who want to purchase a home but fall outside the borrowing requirements for lenders like banks or credit unions (many self-employed folks for example). They will pay a premium to any lenders willing to help them out. Done right, the risks can be minimized and it will provide a lucrative source of income, done wrong, you could end up like these people!
Stocks are also volatile these days and there is no guarantee your return is going be higher than the interest rate on the equity you borrowed to buy them. You may be able to deduct some interest to make it more viable, but it isn’t a low-risk maneuver and may not suit your investment goals and life situation.
Other uses of equity that meet the threshold of a "good use of funds" could be emergencies (health or job loss), funding education, or doing necessary repairs and maintenance to make your house comfortable (not extravagant!).
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