Experts say the best “investment” you can make is to pay your bond off as quickly as possible. But is a home loan a good investment to begin with?
The most important factor when buying a home is to live within your means and only buy a house that you can afford to pay off.
A bond is made up of two parts: the capital, and interest over the loan period. The first 10 years is when your interest repayment is at record levels and only a small percentage goes towards paying the capital. For example, on a R3-million loan where the monthly bond repayment is R29 000, R25 000 goes towards paying interest.
This means the interest you pay the bank over a 20-year period will far exceed the original cost of your house thanks to something called “compound interest” – when interest paid on the investment accrues interest of its own. On a R3-million property, the total amount will be in the region of R6-million. This can be reduced significantly by paying additional money into your bond.
With this in mind, Leadhome COO Harry Hattingh says: “The most financially astute among us will treat a bond as a challenge: to pay it off as rapidly as possible. The rate of return on a bond is the same as the interest rate on the bond – well above market returns achieved by other investment options”.
In the current economic climate and amid recent global volatility, promises of returns that look more attractive than bond interest rates seldom materialise, experts warn. While investing in your bond may not seem as sexy as other options, bear in mind that other investment classes are also subject to much higher risk and fluctuation. By negotiating a fixed interest rate for your bond, you can reduce your financial risk by ensuring that your monthly bond repayments don’t increase.
The general consensus is that if you have spare cash, always service your debt first – especially higher-interest-rate debt like credit cards, car instalments and bonds. You don’t only save on interest when you shorten the bond period; you also build up “equity” – the difference between what your property is worth in the current market and what you owe the bank. If you opt for a ‘flexi’ or ‘access’ bond, you will have access to these funds should an emergency arise and cash is needed.
Even though you may have 20 years to pay off your bond, make it a priority. Paying an additional amount every month will save you thousands on the total interest due. In one online article, BetterBond chief executive Rudi Botha wrote that if you have a R1-million bond, paying an additional R800 every month will mean you pay off your home in 16 years instead of 20 years. And you would save a whopping R300 000 in interest!
Investing in your bond is also a form of tax-free saving as returns earned from investments in an interest-bearing account are subject to income tax. Added bond benefits include the fact that there are no fees or other investment fees or admin costs to pay, unlike investment in shares.
Make sure the bank offers flexibility to pay off your bond earlier. While the temptation may be to spend spare cash on frivolous purchases or holidays, the financial freedom of being bond-free will outweigh any retail therapy. And then you can spend spare cash on growing your wealth further. Reducing the loan repayment period of your bond also makes sense for those wanting to retire or downsize in 20 years. It means you can use your equity to pay cash for a smaller home and not have to worry about rent or another bond.