Pros and cons of using home as a treasure chest

Realising the equity in your house by adding on to your mortgage is all well and good but it can end up costing you more than you think, writes Laura Slattery.

The generation of homeowners that has been sitting pretty in their properties for some time now is in an enviable position. Month after month, increases in house prices add to the value of their assets, while mortgage repayments steadily reduce their debt.

These homeowners, specifically those who bought before the mid-1990s, have lucked out financially on a mass scale, reaping the spectacular benefits of the housing boom.

But all of this wealth is tied up in the deeds of their home. If selling is not an option, the only way to use the surge in house prices to boost their standard of living is to keep on borrowing.

"Topping up" is now something people do to their mortgages, not just their tea cups or their mobile phones.

Remortgaging is a little like topping up, in that additional equity can be converted into cash, but the process usually involves the further step of switching to a new lender.

Both methods work on the principle that first-time buyers can usually borrow up to 92 per cent of the purchase price of a property. This figure is called the loan-to-value (LTV).

As house prices escalate, the outstanding mortgage soon represents a much smaller percentage of the property value, meaning lenders will be happy to advance more at homeowners' request.

And homeowners are increasingly asking for more.

"The level of activity in remortgaging and top-ups has increased markedly in the last three or four years," says Mr Paul Crewe, adviser at Mortgages Direct.

So why are homeowners joining the remortgaging revolution? "There are the obvious reasons, like home improvement. People don't want to move house and have to pay stamp duty," he says.

Instead, they will have fun implementing a new colour scheme, knocking through a few walls and adding on to the back of their present address.

Another reason for following the top-up trend is to raise a deposit for an investment property, a holiday home or an adult child's first home. People are happily using the equity gained from one rung of the property ladder to propel them on to the next.

A third motivation is to clear unsecured finance such as car loans or credit union loans.

This phenomenon - borrowing against the value of your home to pay off other debts - has elicited words of caution from the consumer watchdog, the Irish Financial Services Regulatory Authority (IFSRA).

In its new guide on personal loans and credit, IFSRA notes that many lenders say that using top-up loans to refinance is a way of saving money. These lenders stress the lower interest rate and lower monthly repayments.

But debt consolidation or "refinancing" will only save money if consumers pay off these loans over a reasonably short term, IFSRA warns.

If unwieldy, difficult-to-manage personal loans, overdrafts and credit card debts are simply lumped in with the mortgage and repaid over the same term, it could actually cost consumers more than if they had kept repaying at the higher rates.

The example shown opposite illustrates how adding a home improvement loan of €18,000 and a hire purchase (HP) loan of €10,000 to an existing mortgage of €50,000 could cost a consumer an additional €8,684.

The extra interest is incurred because, instead of repaying the home improvement loan over its original four-year term and clearing the HP loan over three years, it is left to fester over the full 20-year mortgage term.

The trouble is, most people never get around to calculating the total cost of their credit, but focus on exactly how much their monthly repayments will plummet if they refinance.

In the second column from the right in the example shown, monthly repayments drop by more than 50 per cent from a budget-stretching €1,071 to a more manageable €483.

For consumers with a portfolio of pinch-inducing debts, the sheer relief offered by refinancing makes it an option worth considering.

Not all lenders are hugely keen on debt consolidation, especially if it means taking away from demand for their higher margin unsecured loans.

In any case, most people doing top-ups or remortgaging do it to pay for home improvements rather than consolidating existing unsecured debts, according to Mr Ronan Mackey, new business executive at NC Mortgage Brokers.

"Because most of it is for home improvements, most people tend to borrow over the longer term. It's one thing paying back €15,000 for a home improvement over 25 years - you are adding value to the home," says Mr Mackey. "But if you're doing it to buy a car, it's not advisable to pay it back over the full term. They should pay it back within five years, because the car will be well gone by then."

Mortgages Direct issues similar advice to refinancing clients. "But they don't always take that advice if they want to lower their repayments," according to Mr Crewe.

People who are remortgaging or topping up sometimes consolidate a few debts almost as an afterthought: if they're borrowing €25,000 to build a conservatory, what's another €3,000 at a home loan rate of 3.5 per cent to clear a credit card balance attracting interest at 16.9 per cent?

But Mr Crewe says he has had clients who have topped up purely to refinance. "They have taken out a couple of car loans and they have just overextended themselves."

One danger with debt consolidation is that there is little to stop a borrower who has amalgamated their debts into one big mortgage from accruing a whole new set of credit card, personal loan and car loan debts, which they may then seek to refinance at home loan rates later on.

The end result could be a cycle of debt that is never broken and a mortgage that is never cleared.

However, there are safety nets in place. Most lenders will not entertain repeat customers.

"If someone has done it more than twice, questions will be asked," says Mr Crewe.

Hopping from lender to lender won't help: financial institutions can check people's patterns of borrowing and refinancing on their credit records, held centrally at the Irish Credit Bureau.

IFSRA's guide to personal loans and credit lists some questions that top-up and remortgage customers should ask their lender.

These include checking out the APR, the total cost of credit, whether there are any legal or other fees and how much extra mortgage protection cover to insure the new part of the loan will cost.

Another question borrowers should ask themselves is whether it is really a good idea to get deeper in debt at a time when interest rates are forecast to rise and future house price increases are likely to be far less dramatic than in the recent past.

According to Mr Crewe, top-up and remortgage customers are keeping themselves within a comfort zone.

The average value of remortgages has increased by about €15,000 in the past year, he says. But the LTV of these remortgages has fallen from 51 to 49 per cent: very rarely do people remortgage back up to a 70-80 per cent LTV, he says.

Refinancing can even be a shrewd move, he believes.

"Eight years ago, it wasn't accepted. People thought you were in trouble if you had to refinance. Now people are looking to benefit from it."