10 Mar Using your home’s equity as collateral
There are two types of home buyers. There are the cautious ones who would prefer to make decisions that are on the safe side of the spectrum and others who are happy to take risks. The former are the types who would make extra mortgage repayments or ensure that they have adequate savings in case something went wrong and they needed money urgently. The second type would potentially use their existing home as collateral against future purchases. They may use it to fund renovations or a second property. Naturally, as with all things related to property, there are mixed opinions. Some people would be heavily opposed to using their home as collateral saying it’s risky, while others would take the chance of gambling their home on the off chance that they may generate an excellent return.
Whichever side of the fence you are on, there are things that you need to consider when deciding whether or not to use your existing property as collateral on another property.
Nobody would deny that any property purchase will prove risky and that it’s a major commitment, often between 20 and 30 years, so when you’re thinking about cross collateralising your home, you need to consider your capacity to pay back both loans should you lose your job or should tenants move out if it’s a rental property. If either of these issues would cause you mortgage stress, which is where your mortgage repayments exceed 30% of your income, then you definitely should not take the risk, however, if you have a buffer of cash savings lasting up to six months and have other investments, then it may not hurt to do so.
The major question you need to ask yourself is, can I still pay both mortgages if I lose one source of income? If the answer is no then you definitely should not use your home as collateral. It would prove too risky and you could end up using your existing home and still end up with thousands of dollars of debt at the end of it depending on how far into the mortgage you are and if there are any fees for exiting early.
One case where you may be okay to use your existing property as collateral is to help your children purchase their first home. You can help your children in the long run and save them money on future property hikes. Before you make the decision though, you would need to analyse the finances of your children. Are they likely to default on their mortgage? Would they be able to afford an interest rates hike? Can they afford maintenance on their property? Maintenance is a cost that many people do not factor into the property purchase decision, and that’s why tenants in investment properties often complain that their landlords are not repairing the property as fast as they should.
The bottom line and the message to take out of this is that there are certain circumstances where you could cross collateralise your home, but there are others where it would prove very, very risky. you need to analyse a raft of factors and consult with your financial advisor or broker before doing so.
If you have any questions related to this topic, feel free to contact the Aspirus team for a confidential discussion.