Home Refinance: Be Cautious of Piggy Bank Financing

Michelle Tuvey Michelle Tuvey | Loan Underwriter

There have been a couple of stories in the news cycle recently detailing how American homeowners are taking advantage of low interest rates to turn the equity in their properties into virtual piggy banks for the future. There is some speculation that this practice will catch on in the UK if the Bank of England base rate remains at 0.25% for any longer than a few months. Our advice would be to stay cautious of any home refinance strategy based on the piggy bank trend.

The piggy bank trend is one of refinancing a home and using the proceeds from equity to invest in property, stocks and shares, or other options. The principle seems sound initially, but there are a lot of things that could make such a strategy unwise ?? especially here in the UK. Let's start with adjustable interest rates.

What Happens When Rates Go Up?

Unlike in the US, it is virtually impossible to get a reasonable fixed rate mortgage in the UK for 10, 20 or even 30 years. Our model is one that offers fixed rates for two or three years before forcing a borrower to accept variable rates or seek out a new lender offering home refinance deals. The process is so complex that we tend just to take variable rates when they kick in.

Let's say you went for a home refinance deal, took the extra cash from your equity, and invested in stocks and shares. What will you do five years down the road should the base rate suddenly go up to 1.5%? Hopefully, you'll be able to maintain your monthly payments. If not, how will you afford to stay in your home?

You could sell some of your stocks and shares and use the proceeds to support your monthly budget. But that would undermine your strategy of investing for the future. If interest rates go higher, any hope of those investments providing future income could evaporate rather quickly.

Home Refinance Costs Money

The other thing to consider is that refinancing your home costs a lot of money. We are not talking just about the fees and charges associated with getting a new loan; we're also talking about the higher costs of amortisation as you extend your mortgage out further and further.

You have probably paid off a significant portion of your home if you have enough equity to make a home refinance strategy worth considering. But remember that you will lose all that equity by refinancing. And then you'll be back to square one with a mortgage that could stretch on for 10 or 15 more years. You will start paying interest all over again, front-loaded of course, the same way you did when you got your original mortgage.

Caution Is Rarely a Bad Thing

We do not present this information to dissuade you from a home refinance strategy that looks like it could help secure your financial future. We only encourage you to exercise caution. In matters of finance, caution is rarely a bad thing. Before you embrace home refinance to support a piggy bank strategy, take the time to look at all the pros and cons.

It could be that the piggy bank trend is just what you're looking for to provide the future income you need. But you could also find that there are too many risks involved. There is no way to know without taking the time to research and making an effort to think things through. Home refinance will still be available a month from now; there's no need to rush into a decision quickly.

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