Tired of working for money? Turn the tables and make it work for you

In 1776, Adam Smith wrote in The Wealth of Nations “Money, says the proverb, makes money…” A few hundred years later, that old adage still applies, but with the ever increasing cost of living and the corresponding difficulty to save, a very relevant question today is where does one get money to invest to begin with?

Most people have more money making opportunities than they realize, while they sit in their own home and ponder the age old question, where to get investment capital – the most obvious answer is overlooked.

Your own home could very well provide the capital you need to make more money.

With certain exceptions, the general rule of thumb is that your property value doubles every 10 years. To be clear, this is not always the case but for the purpose of this article, we can safely assume that a property bought during and post the 1997 crash would have enjoyed appreciation in the last few years (with the exception of certain property locations which suffered negative growth and other more popular areas where values almost tripled).

So, if you purchased a property for RM250,000 in 1997, its value should be approximately RM500,000 today.

Assuming in 1997 you took a RM200,000 loan (being 80% of the purchase price) with a 30-year tenure to assist in that property purchase, on an average interest rate of 8% per annum, the remaining loan outstanding should stand at approximately RM175,000 today.

A present value of RM500,000 and loan outstanding of RM175,000 gives you a home equity value of RM325,000, a significant amount of capital and a potent financial opportunity to increase your wealth.

However, in its present “brick and mortar” form, the capital is only “paper wealth” and largely redundant in providing annual returns. [Note: your property value appreciates or depreciates regardless of how much loan you have on it]. Money is not making money here.

The home equity is only a potential capital and will not help generate additional wealth unless it is released and converted into another form capable of generating returns. One way of releasing that equity is to sell the property which clearly has more cons than pros. The other easy way is simply to refinance the existing loan and leverage on the home equity that has been built up.

As they say, timing is everything and in the last 10 years economic winds of change have presented a coincidence of 2 factors that permits using the home equity for further wealth creation: (i) appreciation in property values and (ii) sharp drop in interest rates.
The two factors combine to empower the home owner to release more home equity, and at a lower cost.

A home loan taken just before or not long after the 1997 crash would bear a BLR of approximately 8% - 12 %. Today the BLR is 6.75% which means you can borrow the same amount of money with significantly less monthly repayment. It also means that you can refinance your existing loan outstanding plus a bit extra and still pay exactly the same monthly loan repayments and for the same number of years.

In other words, instead of servicing a monthly loan repayment of RM1468, for a loan sum of RM175,000 still outstanding on your original mortgage, the same monthly repayment can support a new [refinanced] loan of RM205,000….or RM30,000 extra. See Table 1

Of course you can also just refinance the outstanding sum and save some money on monthly repayments (approximately RM210 per month) however, (i) you will not have any immediate capital for investment; and (ii) your home equity will still be locked in its redundant zero-return form.

Let us now explore what can be done with the RM30,000 cash that has been released from the home equity:

 Home Repairs & Improvements
Remodel the kitchen or upgrade the bathroom-these are only some of the ways of using the released home equity to improve the value of the property, especially if little has been done to actively improve the property since the purchase.

Improving the property is especially wise for investment properties. Tenants are naturally prepared to pay a higher rental for a property that looks fresh and newly renovated.

Buying other Investments
Using your home equity to purchase stocks, unit trusts funds or other investments can prove to be lucrative, especially in a bullish market like that of today.

A critically important note of caution: Although investment and capital risk exists anytime you enter into any form of investment, you should be extra careful when investing “borrowed capital”. Seek professional investment advice before embarking upon this exercise to ensure that the return on the investment is acceptable against the interest rate risk.

Fortunately, there are specific types of loans available today that will help investors mitigate the interest rate risk and generate wealth with the home equity.

This will be covered further on in this article but in principle, loans with fixed rates, loans with zero-penalty for prepayments and “flexi-loans” are ideal.

Down-Payment for Second Property
As a subset of the approach mentioned above, the leveraged home equity may be used as down-payment for a new (second) investment property. If your mortgage was taken 20 years ago, it should not surprise you to discover that as much as RM100,000 can be released from the current home equity.

Assuming the said RM100,000 is applied as down-payment for a new RM200,000 property, with the remaining RM100,000 taken as another loan against the new (second) investment property, it is likely that the rental income from the new (second) property can render the investment to be self funding and from here, wealth generation takes on a more significant meaning.

In order for you to release a higher sum of redundant home equity and yet maintain the same or a comfortable monthly repayment, you may take the refinanced loan on a longer tenure. With the lower interest rate available today, longer loan tenures can support a higher loan sum without increasing the monthly repayment. Of course, the borrower’s age might be a limiting factor but there are Banks in the market today that lends to age 70 and one mortgage lender that allows term loan tenures to run to age 80 and revolving credit term up to age 100.

Remember that having longer loan tenure does not mean that you are contractually obliged to keep the loan for its entire term. In situations where your home equity is released and applied as down-payment for a second property, you can choose to sell off the second property to pay off/down the loan. So the RM100k home equity extracted before now returns to the loan as principal repayment albeit at a higher sum due to the capital appreciation of the second property. The recent waiver of Real Property Gains Tax is a bonus and makes this method of using home equity well worthy of consideration, especially if your property is carrying a high percentage of redundant equity.

Consolidate Debts
There is a big difference between on the one hand, using the home equity as a bail-out instrument for over-spent credit cards, and on the other hand, consolidating debts with higher interest costs such as an over-draft.

With the former, whilst the home equity may be a lifesaver to avoid incurring a bad credit record, one must exercise extreme care in using it to pay off the credit card bills. The person may end up in yet deeper debts as the basic problem of over spending is not addressed.

However, it does make good sense to replace a more expense loan with a cheaper one.

Home Equity as Cash Reserve
Leveraging on the home equity today can also be a wise move if you anticipate needing a fairly large sum of money in the next few years for an unavoidable expenditure that you have yet to prepare for. Logic dictates that it is cheaper to release the home equity now when the market offers very low fixed rates instead of waiting to borrow in future at whatever interest rate the lenders will be charging then.

Choosing the Right Loan Instrument
For all the good unlocking the home equity can do to enhance one’s wealth generation program, borrowing money always carries with it certain inherent risks.

However, the case must be made to differentiate between (a) presently accepted risk; and (b) new risk. If in using the home equity to generate more wealth you are exposed to new or enhanced risks, then careful thought and analysis need to be carried out before any home-equity leveraging exercise is undertaken.

For clarity, this article does not advocate taking new and enhanced risk by borrowing more money for investment purposes. Instead, it is intended as an examination of the viability of releasing some of your home equity to help you generate money… based on your present exposure to risk which you are already accepting.

In other words, if you already have a mortgage that you are already making repayments to, you already have an exposure to debt and interest rate. This is your presently accepted risk.

So how can you use the redundant home equity and not assume a higher risk? The simple answer lies in using the right loan instrument.

In this analysis, the safest loans to use are the fixed rate loan and the flexi-loan that allows money to flow into and out of the loan freely and without penalties.

Let us start with the latter. Using the earlier example of using RM30,000 released from the home equity, a flexi-loan allows you to “park” this capital in a Current Account linked to the mortgage. The loan interest rate is calculated based on the interest on the total loan less the sum of money parked in the current account. In other words, so long as the RM30,000 remains in the current account, it offsets the loan interest and the borrower is no worse-off in terms of interest rate charges.

Interest is only calculated and charged as and when part or all of the RM30,000 is used and even then, only for as many days as the said sum is used.

The Flexi-loan allows the person to use some or all of the leveraged home equity of RM30,000 at just a shade over 4% per annum ( in first year) to capitalize on investment opportunities that might yield a much higher return on capital over three to six months.

The assumption here is that the person is somewhat financially savvy and will monitor the investment to make the necessary profit taking or reversal of investment back to cash in the current account.

An easier and on many levels, much safer loan instrument to use to leverage on the redundant home equity is the Fixed Rate Loan which can be as low as 5.99% per annum. The fixed rate enables a person to gear up to a loan sum that corresponds to a comfortable monthly repayment.  As Table 1 shows, a person can refinance to a new loan of RM205,000 to release RM30,000 for investment and yet pay the same amount of monthly repayments as before, and for the same number of remaining years.

Remember, the person was paying RM1,468 anyway and now with the same repayment he has a capital of RM30,000 to invest. And with a fixed rate loan, there is no risk of him having to pay more if/when rates increase. Hence the present and accepted risk remains unchanged.

In fact, the person’s risk position improves by switching from a floating rate (BLR based) to a Fixed Rate (not based on BLR). Historically BLR has spiked to over 12% in each decade.

One might be expected to think that with a cost of 5.99% p.a., you would need to place the released equity into an investment that returns higher than 5.99% p.a. On the contrary, a fixed rate term loan allows you to invest the 30k extracted at a cost of 5.99% p.a. in a fixed deposit account at an average of only 4% p.a. and STILL MAKE MONEY over the remaining loan tenure.

The reason is simple. Unlike a credit card or an over-draft facility, a Term Loan is calculated on a reducing balance with each monthly repayment of RM1,468 reducing the actual loan sum. A fixed rate of 5.99% p.a. on a constantly reducing loan balance means the actual sum of interest lost reduces as each repayment is made.

On the other hand, if the RM30,000 is placed in a Fixed Deposit at 4% interest p.a. the interest  compounds, which means at the same 4% p.a. the actual sum in FD increases each year as interest is added on to interest. It is interesting to note that actual average of FD returns over the last 20 years is approximately 6.2% p.a.

In this scenario, an interest rate hike is actually a positive development.

In summary, using the home equity of RM30k with a loan interest of 5.99% p.a. would “cost” the borrower approximately RM21, 000 in interest over 20 years. In that same time period, the same amount placed in FD at only 4% interest p.a. would grow to almost RM67,000 (or approximately RM81, 000 @ 5%p.a. interest; and almost RM100,000 @ 6% p.a.). See Table 2

Note: The interest repayment and amortization of the RM30k is already factored into the monthly term loan repayment of RM1468 and no additional cash outlay is required.

Whether the return is RM67,000 or RM100,000 or even more, the simple fact is that the person will have more money by the end of the loan period that he would, had he not used his redundant equity to work for him.

Finally, the additional bonus is that the range of Fixed Rate Loans available in the market today comes with Zero Entry Cost which means that the borrower does not have to outlay any money for the entire refinancing and equity release exercise, and with Zero Lock In which means the extracted equity can be returned to the loan as prepayment or to close off the loan.

If you need assistance to find out how to get your home equity to work for you, kindly dial a WISECall @ 1800-18-8805. WISE has a range of analysis tools to help you