For many home buyers, their priority is the property’s function as a home and not much attention is paid to the investment aspect beyond the fact that real estate is generally a solid long-term investment, however, understanding its equity can make a big difference in managing finances, making home improvements and building wealth over time.
This is according to Cobus Odendaal, CEO of Lew Geffen Sotheby’s International Realty in Johannesburg and Randburg, who explains: “Home equity is the financial stake you have in your home, and if you're like most people, it's a large portion of your total net worth. However, it’s more than just a number on paper; it’s a valuable asset that can help build long-term wealth, provide financial security, and offer access to low-interest borrowing options.
“In a nutshell, home equity is the portion of your home’s value that you truly own, free and clear of any debt. When you purchase a home, you typically finance a large portion of it through a bond, making regular payments over time.
“And, as you continue to make payments and your home's market value appreciates, your equity in the home grows. In other words, home equity is calculated by taking the market value of your home and subtracting the amount you still owe on your bond.”
Why Is Home Equity Important?
Odendaal cites the following reasons:
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.
READ: Here is what you need to know about consolidating debt
Andrea Tucker, Director of MortgageMe previously shared that having a thorough understanding of the costs involved in the sale of a house in relation to the current value of the property is important in avoiding a major financial misstep. “In theory, downsizing should be kinder on your pocket thanks to lower maintenance costs and as well as rates, taxes, and electricity savings. In the short term at least, a move to another home comes with sizeable expenses, so it pays to do the sums before making a final decision,” notes Tucker.
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The positives of going smaller
- Fewer maintenance costs
- Cheaper utility bills
- More affordable homeowners insurance
- Smaller bond repayments
A potential cash windfall. Assuming you’ve lived in your current home for some time and your property has increased in value, by purchasing a smaller home you’ll have equity leftover that you can spend or invest (our vote is for invest!) as you see fit.
Fewer interest payments. Buying a cheaper property using the proceeds of the sale of your larger home means significant interest payments over time.
The cons of downscaling
- Less space. As the name suggests downsizing means less space and an adjustment in getting used to a new lifestyle.
- The possibility of more rules. Moving from a freestanding home to an apartment under a sectional title may mean getting used to complex rules, body corporates, and paying common property maintenance fees.
- Playing furniture Tetris. Before you move consider your furniture. What fits in your current spacious lounge might be an impossible squeeze elsewhere. Is selling your existing furniture and buying new part of the plan?
- Costs for you as a seller. These include bond cancellation fees, compliance certificates, estate agent fees, outstanding repairs and maintenance costs, as well as advance payments on municipal rates and taxes which are payable prior to your conveyancing attorney lodging any transfer documents to a new owner.
READ: Pay less for your home by building equity
Improves Home Value Through Strategic Investments
Investing in home improvements can increase your property’s market value, thus growing your equity and projects that enhance your home’s appeal, such as kitchen remodels, bathroom upgrades, or landscaping, can significantly increase your home’s resale value. When making improvements, focus on those that will yield a higher return, enhancing your home's marketability and boosting your equity in the long run.
Acts as a Financial Safety Net
Having equity in your home can provide peace of mind in case of financial hardships and home equity loans can help you manage unforeseen expenses or emergencies without selling assets or borrowing at high interest rates. When used carefully, home equity can be an effective safety net in challenging times.
“While home equity can be a powerful tool, it’s important to consider the risks associated with borrowing against it,” cautions Odendaal.
“When you take out a loan secured by your home, you put your property at risk if you can’t keep up with payments. Additionally, market conditions can affect your equity so if the value of your home drops, you could find yourself with less equity than expected, or in a situation known as “negative equity,” where you owe more than your home is worth.
“Using home equity responsibly means borrowing only what you need, understanding repayment terms, and ensuring you have a plan to pay back what you borrow. With careful planning, you can make the most of your home equity to support your financial goals and secure a solid foundation for the future.
Odendaal concludes: “Remember the golden rule: Use your home equity to build wealth, not simply to fund lifestyle expenses.”
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