Lavanya and Paresh Malhotra are looking for ways to raise funds and saving for goals. One of their earlier investments was in a house in which they now live. This has appreciated in value and the Malhotras are looking at taking a home equity loan, tempted by the lower interest rate, longer tenure and small monthly repayments. They feel they can use this locked-up value of the house to meet some goals and obligations. What are the factors they must consider while doing this?
Lavanya and Paresh must consider the consequences of their decision to encash their home equity. This is typically seen as a nest egg to be used in retirement, if needed, and to fall back on in case of an emergency. If they use the home equity now, it may impact their financial security and ability to achieve their retirement goals. They must also consider their ability to service the loan and should ensure that their monthly income is adequate to meet the loan obligation. If not, it will put their house at risk since the loan will be secured on the house.
The Malhotras must not consider this loan to meet any consumption or lifestyle expenses. These can be easily postponed till they can meet these from their regular income through a combination of savings and loan. Using the funds to repay a high-cost loan, such as the outstanding balance on a credit card, can be considered only if they are serious about staying away from such a situation in the future. Besides, they will be merely substituting an unsecured loan with a secured one of longer tenure and with more serious consequences of a default. They must first consider paying their debt by cutting back on expenses and finding funds from their income.
Using the home equity loan to invest for their goals implies finding an investment that will give a return high enough to cover the cost of borrowing and additional return. If the investment does not perform well, they may have to bear the cost of the loan or lose their house and find themselves in a worse financial situation.
They should save the equity as a reserve to meet emergencies, such as health care costs, which may require a large outlay, or to finance an important goal, if they are sure they will be able to repay the loan quickly.