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Using Home Equity for Non-Essential Expenses - The Definitive New Zealand Guide to the Pros, Cons and Risks

Our guide outlines the benefits and risks of using home equity to pay for non-urgent expenses, alongside common traps and problems and alternatives to dipping into home equity to pay for big-ticket items.
Updated 14 June 2024

​Summary
  • Many New Zealanders consider paying off personal debts by borrowing against their house. This became attractive during the pandemic when mortgage rates were around 2.50% p.a., compared to personal and car loan rates of 10%+ p.a. However, this approach can create a debt trap and should be carefully considered.
  • Using your home as collateral for expenses like buying a car, eBike, spa pool, or financing a renovation involves significant long-term financial risks. For instance, adding a $30,000 debt to your mortgage means you'll be repaying it over many years (alongside your mortgage).
  • While the interest rates may appear lower, paying off a $30,000 loan over 20 years at 7.50% p.a. is much more expensive than paying the same loan off over three years at 12.99% p.a.
  • This guide explores these risks in detail, helping you make informed financial decisions about how to pay for non-essential purchases. 

​Our guide covers:

MoneyHub Founder Christopher Walsh shares his views on the risks of dipping into home equity:

"Raiding your home equity for non-essential expenses is a surefire way to move backwards financially. Tapping into your home equity for immediate gratification is tempting, but the long-term consequences can be severe. With current fluctuations in house market values, you risk losing significant equity if home values drop. Every dollar you take out of your home must be repaid, with interest, over a very long period.

Using home equity to buy a car, consolidate debt or do a renovation jeopardises your financial stability and limits your options for future borrowing or refinancing should house prices fall. In a worst-case scenario, you could owe more on your mortgage than your home is worth (negative equity), which is incredibly difficult to recover from.

Instead of leveraging your home equity, I believe it's best to focus on reducing existing debts through structured repayment plans. The key to financial freedom is paying off your mortgage, not using your home as a bank to fund non-essential purchases. This approach may seem slower and less 'fun', but it builds true financial security and reduces the risk of losing your most valuable asset – your home". ​
Christopher Walsh
MoneyHub Founder

The Benefits of Using Home Equity to Pay for for Non-Urgent Purchases

1. Lower Interest Rates (Compared to Personal Loans or Credit Cards)
Mortgage rates are typically lower than personal loan or credit card interest rates; personal loans can have interest rates ranging from 10% to 20% p.a., while mortgage rates can be found for around 6% to 8% p.a. Before considering the term you borrow for, home loan interest rates are lower, and this can result in lower monthly payments and reduced interest costs over time if it's a short-term repayment. However, many New Zealanders repay such debt over the long term; this usually makes the total debt cost much higher than short-term loans.

2. Simplified Monthly Payments
Consolidating multiple debts LINK and merging them with your mortgage can simplify your ongoing debt repayments. Instead of managing several payments with different due dates, interest rates, and terms, you only need to anticipate one payment - your mortgage. While this can make budgeting and financial planning more straightforward, reducing the risk of missed payments and the associated penalties, the interest costs incurred over the long term are often far higher.

3. Increased Property Value (for Home Improvements)
While reliable house valuations are hard to estimate, and the effects of renovations on house prices are uncertain, using home equity to finance home improvements can increase your property's value. Strategic renovations such as modernising kitchens and bathrooms, adding extra rooms, or improving energy efficiency can significantly boost your home's market value and lower power costs. However, you will pay interest on the debt alongside your mortgage until you sell your home or repay the mortgage in full, and any profits are not realised until you sell. 

Our view is simple - home equity financing is poor value in the long term, and we outline why in the sections below. However, there can be instances when it could be a cost-effective option:

1. Major Renovations that Increase Property Value (If You're Considering Selling)
  • For example, adding an extension, renovating a kitchen, or upgrading bathrooms. These improvements can significantly boost your home's market value, potentially providing a return on investment that outweighs the interest costs.
  • However, you'll need to get competitive pricing, focus on high ROI projects such as kitchen remodels or bathroom upgrades, and look at energy-efficient upgrades which can help boost a sales price.
​
2. Major Medical Expenses
  • If the waiting lists are too long, or your recommended treatments won't be covered by the public health system, using home equity financing could be a low-hassle option that avoids you having to make repayments to a personal lender. Instead, you'll keep up with your mortgage (and the extra repayment amount arising when you pay for medical costs using equity). 
  • However, before making any decision, it's essential to compare the interest rates and terms of home equity loans with other financing options to ensure you get the best deal. You'll also need to have a clear and realistic repayment plan to repay the debt, whether it be a personal loan or home equity, to avoid extending your debt over a longer period than necessary.

The Real Costs and Risks of Using Home Equity to Pay for Purchases

To explain how 'putting it on the mortgage' can incur significantly higher interest costs, we look at typical examples for home improvements, debt consolidation, buying a car, e-bikes, and spa pools. By comparing these expenses with shorter-term financing options, we illustrate the long-term financial impact and the risks of using home equity for such purchases.

1. Home Improvements

Despite Kiwi enthusiasm for renovations, the return on investment (ROI) for home improvements is never guaranteed and can vary greatly depending on the quality of the work, the (general) New Zealand housing market and local property values. For example, while a kitchen remodel might seem like a way to improve home prices, the actual gain may be less if house prices drop or the renovation is not appealing to potential buyers.

The actual costs can compound and become a debt drag. To demonstrate this, let's compare a 5-year personal loan at 11.50% p.a. with a 20-year mortgage at 7.50% p.a. for a $75,000 renovation:

Personal Loan (5 years at 11.50% p.a.)
  • Monthly payment: $1,649
  • Total interest paid: $24,956
  • Total cost: $99,956

Home Equity/Mortgage (20 years at 7.50% p.a.)
  • Monthly payment: $605
  • Total interest paid: $70,220
  • Total cost: $145,220

Summary:
  • Using a 5-year personal loan, the total cost is $99,956. However, using a 20-year mortgage, the total cost balloons to $145,220 due to the extended repayment period, significantly increasing your financial burden over time.
  • This is because the longer you take to repay, the more interest you pay, and initial payments primarily go towards interest, delaying principal reduction.
  • We believe that higher mortgage repayments increase the risk of affordability issues, making it harder to manage your overall financial commitments than a personal loan, which can be unsecured and repaid early without penalty.

2. Debt Consolidation

Our guide to the dangers of debt consolidation loans provides more information about the costs, risks, and facts that must be considered.  

3. Car Loans

Purchasing a car using home equity might seem attractive due to potentially lower interest rates compared to car loans. However, cars are depreciating assets, meaning their value decreases over time. Spreading the cost over an extended mortgage term can result in a long-term financial burden.

To demonstrate this, let's compare a 5-year car loan at 11.50% p.a. with a 15-year mortgage at 7.50% p.a. for a $35,000 car purchase:

Car Loan (5 years at 11.50% p.a.)
  • Monthly payment: $770
  • Total interest paid: $10,209
  • Total cost: $45,209

Home Equity Loan (15 years at 7.50% p.a.)
  • Monthly payment: $324
  • Total interest paid: $23,667
  • Total cost: $58,667

Summary
  • The total cost of a 5-year car loan is $45,209; however, the total cost of a 15-year mortgage balloons to $58,667 due to the extended repayment period, significantly increasing your financial burden over time. This is because the longer you take to repay, the more interest you pay, and initial payments primarily go towards interest, delaying principal reduction.
  • Additionally, cars are depreciating assets, meaning their value decreases over time. Spreading the cost over a long-term mortgage results in paying more for an asset that loses value, further increasing your financial commitment.
  • We believe that higher mortgage repayments increase the risk of affordability issues, making it harder to manage your overall financial commitments.

4. eBikes and 5. Spa Pools

Purchasing luxury items like eBikes and spa pools using home equity can provide immediate enjoyment and convenience. However, these items do not appreciate in value and can become long-term financial burdens.

How much can a $10,000 pair of eBikes and a $40,000 spa pool cost in the long term?
Let's compare a 5-year personal loan at 11.50% p.a. with a 20-year mortgage at 7.50% p.a. for a total purchase of $50,000.

Personal Loan (5 years at 11.50% p.a.)
  • Monthly payment: $1,099
  • Total interest paid: $16,637
  • Total cost: $66,637

Home Equity Loan (20 years at 7.50% p.a.)
  • Monthly payment: $403
  • Total interest paid: $46,813
  • Total cost: $96,813

Summary:
  • Using a 5-year personal loan, the total cost is $66,637. However, using a 20-year mortgage, the total cost balloons to $96,813 due to the extended repayment period, significantly increasing your financial burden over time. This is because the longer you take to repay, the more interest you pay, and initial payments primarily go towards interest, delaying principal reduction.
  • Finally, higher mortgage repayments increase the risk of affordability issues, making it harder to manage your overall financial commitments than a personal loan, which can be unsecured and repaid early without penalty.

The Common Traps and Problems with Using Home Equity to Cover Debts and Non-Essential Expenses

Using home equity to cover the cost of non-essential expenses can quickly lead to prolonged debt and significantly higher interest costs over time. We outline the key risks below to help you fully understand the drawbacks and other limitations of putting purchases 'on the house'.

Spending Habits May Not Change and Debt Will Continue to Grow

If you don't see the debts and only pay a higher mortgage repayment, it may feel like you've not spent the money. A $30,000 car purchase won't cause a significant repayment increase on a $500,000 mortgage. However, repaying a $30,000 car loan over three years will cost a lot more and needs careful budgeting.

The danger is that you may find yourself using your home equity to buy things you don't need when you don't see the costs. This means the underlying issues that led to the debt creation, such as overspending, holds you back. Too many New Zealanders have so little money and putting non-essentials onto a mortgage is a proven way to hold you back financially.

Adding Debt Creates an Instant Risk to Your Home

If you consolidate your debt or buy new things and add it to your mortgage, your home becomes the collateral. This means your home can be sold if you fail to make payments later due to financial hardship. Loading a mortgage up with debt adds more repayment stress, which continues to worry many New Zealanders given the amount of homeowners behind on their mortgage per this May 2023 RNZ article.

For example, you could lose your home if you borrow $50,000 against your home to pay down car debts, personal loans, credit card balances and later default. This is a significant risk compared to unsecured debt, where the consequence is limited to damage to your credit score and financial history.​

Putting (Even Small) Personal Debts on a Mortgage Creates Significant Long-Term Costs

While we outline this in detail above, if you borrow $20,000 against your home at an interest rate of 7.50% p.a., and your mortgage term is 20 years, the total repayment amount over the life of the loan would be approximately $38,800. This includes substantial interest payments due (around $18,880) to the long repayment period. Any fees you incur to get this loan will be added, which is why 'putting personal debt onto the house' is an expensive long-term cash burner.

Important: Before signing any loan agreement, review the terms and conditions and make sure you understand and appreciate the total cost of the loan, including fees and interest, before deciding to consolidate your debts.

Adding Debt to a Mortgage is Expensive and It's Almost Always Cheaper Just to Pay Off Your Existing Debts by Order of Most Expensive Interest

Instead of consolidating debts and adding them to your mortgage, you might find paying off your existing debts cheaper and more effective using methods like the debt avalanche.

This approach involves paying off debts with the highest interest rates first while making minimum payments on others. By tackling high-interest debts first, you reduce the total interest paid over time and accelerate your path to becoming debt-free.

Example: If you have multiple debts, such as a credit card with a 23.99% interest rate, a personal loan with a 12.99% interest rate, and a car loan with a 9.99% interest rate, focusing on the credit card debt first will save you the most money in interest payments. Once the credit card is paid off, you can then focus on the next highest interest-rate debt, and so on.

Suggested approach: Make a list of all your debts, including their interest rates and balances, and prioritise paying off the highest-interest debt first. Use all spare money you have to make additional payments on the highest-interest debt. This approach saves money and provides a clear, structured path to becoming debt-free.

Adding Debt to Your Mortgage Can Reduce Home Equity

​By diverting equity to pay for purchases, you reduce the amount of equity you have in your home. This can limit your options for future financial needs, such as taking out another mortgage or selling your home for a significant profit. Unknown to most New Zealanders, given the belief that property prices always increase is the issue of house prices falling - however, they do. This NZ Herald story from June 2024 confirmed that thousands of New Zealanders saw their home equity (their deposits) wiped out by overpaying for homes in 2021 and 2022.

With the ongoing issues of property value declines, adding debt to your mortgage could exacerbate your financial risks. If the market experiences a downturn, you might have less equity than expected, which can severely impact your financial stability.

Moreover, lower home equity can affect your borrowing power. Should you need to refinance your mortgage or apply for another loan in the future, having less equity can result in less favourable terms or even denial of additional credit. This scenario can be particularly challenging if unexpected expenses arise, such as medical emergencies or urgent home repairs, leaving you with fewer financial options.

Alternatives to Home Equity Financing

We believe more debt is the worst thing to add to a home loan. To avoid this, we suggest considering these alternatives:
  • The best way to avoid taking on debt is to ask yourself whether or not you need to make the purchase - it's also likely that there will be a cheaper alternative. 
  • If you are determined to purchase, we suggest getting a budgeting app to see where your money is going and where you can save.
  • Personal loans (with shorter terms) force you to make regular repayments. The shorter the term, the less interest you'll pay overall, even though the interest rates may be higher than mortgage rates. This can be a more cost-effective solution for financing non-essential expenses, as it reduces the long-term financial burden and keeps your home equity intact.​
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