July 2003

Has the value of your house increased by thousands in the last few years?

Does it give you a warm, slightly smug feeling inside?

And why not? The value of your pension and any share investments you have has probably gone down over the same period, so it's nice to know that there is some compensation for all that money you've been paying every month.

Since your house is now worth so much more than you paid for it, what's wrong with laying your hands on some of those profits and spending it on a luxury holiday or a nice new car?

Well think about it for a while. Whose money will you really be spending?

Mortgage Equity Withdrawal is one of those cunningly misleading phrases invented by the mortgage companies to encourage people to borrow more money. It would more accurately be described as a low interest secured loan. That's right. The money you are about to spend on your new car or holiday is a loan, secured against your house (meaning that if you don't pay it back with interest they can force you out of your home) and repayable over anything up to 25 years.

So get this, you'll still be paying for that holiday or car for the next 25 years.

The implied concept that you are somehow spending profits from your home is of course, completely false, although you won't hear the lenders explaining this in any of their TV advertisements. The only way you can really profit from the increase in value of your home is to sell it. It's as simple as that, I'm afraid. But then, where are you going to live?

Then you have to consider what would happen if the value of your house actually goes down. Yes, having borrowed against the rising value of your house, what if the property market re-adjusts back to its long-run average over the next couple of years or so (as plenty of people think it will) and your house actually loses 20-30% of its value? You might regret having borrowed and spent all that money, and it could even land you in negative equity, where the value of your home is less than the size of the debt secured against it. Then what are you going to do?

You could just treat 'Mortgage Equity Withdrawal' (long-term, secured loans) as a way to borrow at low interest rates. However, the trouble with borrowing to buy consumer goods over a 25 year period is that:

• The purchases you have made will most likely be depreciated and rendered worthless many years before you have finished paying for them.

• Low intererst rates mean low salary increases. A lot of people don't understand this, and see low interest rates as cheap money. Over the duration of a long-term loan, however, the 'cheapness' of borrowing is rendered irrelevant as earnings rise roughly in line with interest rates.

• The loan is secured against your home, and if you can't make the payments you will lose your house. Do you want to risk that for the sake of this year's fashionable 4x4 car or a luxury holiday? Nobody can force you to sell your house if you default on an ordinary, unsecured personal loan.

• Interest rates are certain to rise at some point in the next few years. If that happens then your salary may start to increase again, but chances are that interest rates will rise a whole lot faster, and may well mean that your monthly payments become unmanageable.

• The rate of interest on your extended mortgage loan may appear to be low at just 5% per annum, but over 25 years, this works out at 125%! Compare this to a personal loan at 8% over 3 years, which works out at 24% and you will realise that this is very far from a cheap loan.