Borrowing for investment has risen dramatically in the past decade. Figures released by the Reserve Bank last month (January 2003) show that almost one in every two housing loans today is for investment purposes, compared with just in one in every six housing loans at the beginning of the 1990s. And this is without counting the billions of dollars of margin loans written every year.

A number of factors have driven the boom, in particular the desire to participate in surging property prices and the attractive tax benefit of deductible loan interest costs.

Easier and more affordable finance is also a key driver of activity. Home equity loans, which now account for about 14 per cent of all loans secured by residential property, have been at the forefront of these developments.

Is it, however, a case of market forces overtaking the fundamental needs of the personal investor? Is borrowing to invest still a good strategy for building wealth in a nervous property market?

Scott Brouwer, director of financial advisory firm Flinders Partners, says home equity loans are still "a fantastic strategy" for boosting wealth for the person who makes the right kind of investment over an appropriate period. "They are not something for speculators. It's too risky for that - you are effectively betting your own home - but a home equity loan used to finance quality growth assets over five to 10 years is a different story. You can be assured of good investment gains and tax benefits, which makes a home equity loan for investment a winning strategy."

Property is still the most common investment financed by home equity loans, reflecting Australian's traditional preferences, but shares are gaining ground as Australians become more educated about growth assets.

He says home equity loan money should always be used to finance investments rather than holidays, boats and other non-appreciating assets to prevent the erosion of equity in the family home. Sticking with this strategy also makes the interest costs of the loan tax deductible and much cheaper after tax than even their primary mortgage.

"Home equity loans are not for everyone. You need to be a disciplined borrower who can resist the temptation to take advantage of the easy access to funds. Some clients find it difficult to manage debt and we advise them to take out a principal and interest loan with regular repayments."

Brouwer says people are just starting to realise that value of investment properties bought with a home equity loan could go down.

"This is cooling enthusiasm for home equity borrowings - investors are not prepared to put their neck in the noose to quite that extent. However, the desire to invest in property is still strong. They are being more choosy and trying to get better quality property."

Sylvia Dickson, managing director of financial advisers Dickson Bonacci, says there is increased awareness of home equity loans for investment, although it is usually for further property purchases.

"For clients for whom gearing is a recommended strategy, we would always suggest they borrow against property for investment rather than use a margin loan where possible. The advantages are usually a lower interest rate, the potential for a higher loan to value ratio and an absence of margin calls," says Dickson.

"However, I am concerned that people are being encouraged to use their home equity because they have it, rather than because it's a necessary or sensible part of their personal strategy."

Dickson says the only point to gearing is to leverage into growth assets, and that sometimes gets overlooked in the rush to get a tax benefit.

"It's also important that borrowing to invest is not an isolated part of an individual's personal finances. Geared investments should not be done in isolation, but I suspect in many cases it is.

"Borrowing to invest must be beneficial for the client and appropriate to their circumstances and their risk profile. It's really only suitable for people who have surplus income and who understand the nature of growth assets, especially when the risk's magnified by gearing."

Dickson adds that usually with investment in growth assets her firm recommends a minimum investment time of about five years, but extended to seven to 10 years for geared investments. "This longer time horizon is desirable in view of the greater risks of geared growth assets."

The home equity loan first made an impact in the retail market in the mid-1990s when the State Bank of NSW (SBNSW) launched its Viridian line of credit. SBNSW is long gone, absorbed by Colonial and then the Commonwealth Bank, but Viridian continues to thrive as the Commonwealth Bank's flagship home equity loan product. Nick Kennett, executive general manager, retail customer services of Commonwealth Bank, says home equity loans are particularly good at reducing debt and building equity quickly. He says home equity loans have steadily evolved in the past few years. The absence of any major feature changes has given the market an opportunity to get comfortable with the product, and acceptance has increased. However, it's a product for specific customers and their needs.

"Our bankers are careful to explain to prospective customers the responsibilities that go with a home equity loan. In fact, most home buyers are very good at managing their own debt and taking responsibility," says Kennett.

"But it's also about whether the loan is right for your needs. About 10 per cent of our customers use a home equity loan, so it's not something for everyone."

John Harries, general manager, mortgages at ANZ Bank, says investors understand the benefits of home equity loans better than the mass market, but sometimes buy more features and flexibility than they really need. "It's important for an investor to think about what is their core debt versus their investment debt. If investment debt is a stable amount, such as for the purchase of a flat or unit that doesn't need further outlays for renovations, it may be better to have a regular loan than a home equity loan," he says.

"It costs less because it has fewer features, but in many cases the investor doesn't need the extra flexibility of a home equity loan. The opposite is true if the borrower is frequently buying and selling investments such as shares or managed funds," says Harries.

The average interest rate on a home equity loan was 6.5 per cent in 2002, according to financial products research house Cannex. While this is in line with the standard variable home loan rate, many home owners achieve closer to 6 per cent by taking advantage of basic loan deals or package deals with major banks. Many home equity loans also have annual fees of between $250 and $350 a year, but the application fee is sometimes waived if the customer already has a mortgage with the lender.

Home equity loans are often promoted as full transactional accounts, designed to receive direct salary credits. This offsets every dollar of day-to-day savings against your home equity loan, reducing loan costs and building equity faster.

Cannex managing director Andrew Willink says if direct salary credits to reduce your mortgage is the drawcard rather than having a line of credit, you do not necessarily need the revolving line of credit. A loan with redraw may be sufficient. "In many instances the interest rate on a home equity loan is higher than the standard, amortising home loan with redraw. So if the need for a revolving credit limit is not necessary, then perhaps this is not the best option."

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