How to release the cash in your home

A home with lots of equity can be like a savings bank - but there are limited options to freeing up the cash.

The concept of "spare equity" is a new one. In the old days Kiwis aimed to pay down their homes and clear the mortgage. Now they see their equity as a tool to be used.

Consequently homeowners sitting on a $1.5m home that is largely paid off have investment options. They could sell and buy both a smaller house/apartment to live in and a renter to bring in income.

A more common trend for Aucklanders with good chunks of equity under their belts, says Stuart Wills, mortgage broker of Mortgage Link Auckland, is to downsize to locations such as Tauranga, Hamilton and Warkworth, which frees up capital.

Many don't want to sell their Auckland bases -- at least for a couple of years, says Wills, and keep it as a rental. At current interest rates the rent on a $1m home in West Harbour, will pay the mortgage on a $660,000 equally nice property elsewhere.

Wills gets one or two inquiries a month from potential clients who want to do just this.

Typically they want to hold on to the Auckland property for now to ensure they've made the right decision.

In a rising market it also keeps capital gains ticking over until they're ready to sell.

The problem with this approach is tax.

People assume that they can deduct the mortgage interest from the rent on their erstwhile home.

Not so, when the money was borrowed against the new home with the old home as security, says Mark Withers, partner at Withers Tsang & Co accountants.

"The deductibility of interest against the rent generated is determined by the use to which the borrowed money was put," says Withers. "So, if you borrow to buy the new home and give the old home as security, the interest is not deductible against the rent, leaving you with a tax bill on the rent and a new mortgage to service."

The way around this is to restructure the ownership of the old home. That however means the old property has been sold and rebought by a trust, company or partnership, making the owner liable for tax on any capital gain if sold again within two years, says Withers.

He adds that the numbers don't stack up. In Auckland owners may only get a 2 to 3 per cent net return after expenses on the value of the property.

"If your borrowed money costs 5 per cent, is this really a wise investment?" says Withers.

Another route taken by empty nesters, says Wills, is to subdivide their existing property. He has one client out west who is in the process of borrowing money to do just this. The second home will be rented to the couple's daughter, which is a win-win situation for the extended family.

Home owners do need to beware of thinking that the equity in their home is "spare", says Wills. He has spoken to clients who are borrowing against their homes to take big risks, such as investing the money in Peer to Peer lending or the sharemarket because they are convinced the returns will be higher than the mortgage interest they're paying.

Borrowing money to make money this way comes with danger written all over it. Just look back at the 1980s stock market crash, where ordinary people were borrowing money to invest in shares they thought were sure-fire bets. Many lost a huge chunk of money when the market crashed.

Less risky is the traditional route of selling the family home, buying a smaller one to retire in and investing the leftover capital in sensible investments that will produce a mix of capital gain and income to supplement NZ Super in retirement.

Taking on debt at this age isn't always sensible, says Withers. "If you want further income, downsize the property and invest the difference for income."

That might be a rental investment. But the money could be invested in a middle-of-the-road investment fund.

Another common approach, says Wills, is to buy a business. He cites the example of a couple who bought a rundown backpackers' lodge. The husband kept his day job and did renovations at night, while his wife ran the business.

There are potential issues with buying a business. Too many borrowers use the money to buy retail businesses, which don't prove as lucrative as they hoped, says Wills. They also lose their safe and secure income from the day job.

The riskiest thing to do is sell the house and put the money in the bank waiting for the next crash.