M Yingwane asks: My wife and I have two houses. We need to decide whether to sell the one house and settle our debts or to hold on to the house and wait for the value to go up?
The first house I bought was for R334 000 in 2007 and is worth R520 000 today. Until we bought our second house we paid double the required mortgage repayments.
The second house I bought in 2009 for R900 000 but it is worth about R1,2-million.
We rent out the first house for R3 500 and the repayments are R2 790. We still owe R260 000 on the first house. Should we sell the first house for the R260 000 profit and lower the bond on the second house or wait until property prices are higher?
Maya replies: This is a difficult question to answer without knowing more about your total financial situation. However here are a few points to consider:
Keeping the investment property
Option one: On the face of it you have a home you are living in (I am assuming the second house valued at R1,2-million) and managing to repay the mortgage while at the same time you have a second property that is paying for itself.
That sounds like a good investment. You don’t mention running costs, but possibly the R700 difference between the rental and mortgage repayment covers that.
If interest rates stay at reasonable levels and you are able to increase your rental by 6% a year, within about seven to eight years you will have a debt-free property that provides you with an income that grows with inflation. You also have a growth asset that will hopefully keep its value.
The risk is that interest rates rise faster than expected. However, given your current rental vs mortgage that is not likely to impact too severely.
Selling the property
If you sell the property you will be able to lower your debt. The question is what would you do with this saving?
Option two: If you continued to pay your current mortgage repayments (I am assuming about R8 000 per month based on the purchase prices) then you would have paid off your home within 10 years and saved a massive R709 815 in interest.
Option three: If you paid the lower mortgage amount of R5 760 and invested the saving (R2240) in an equity unit trust or exchange traded fund, it could be worth around R486 000 assuming an average return of 11%. You would have a home that has increased in value and an investment in an asset class that is not closely correlated to property (in other words property and equities tend to perform at different times. This lowers the overall risk of your total investments).
Option four: Alternatively you could invest the R260 000 as a lump sum in a unit trust or exchange-traded fund. Within 10 years you could expect it to be worth about R770 000 (note this is similar to the interest you would be saving)
Making a decision:
All of these options have their benefits, but which one you select will be determined by your other savings. Do you have retirement savings? Do you have additional savings over and above your retirement savings?
The key with any financial plan is that it is diversified and that you have a range of investments. There is no point in having a debt-free roof over your head but no money to buy food!
Option one — keep the property: If you have a sufficient retirement fund, then an investment property that can provide a passive income in a few years’ time is a great idea.
Option two — pay off your home: If you have a retirement fund and additional savings that will provide you with a lump sum so that you have choices later in life, then getting rid of your mortgage debt is a good option. Just make sure you have an access bond so that this can provide you with flexibility and a safety net should you run into financial difficulty.
Option three — invest the monthly savings: If you do not have a retirement fund or other savings you need to start building this up, especially before the age of 35 in order to benefit from the power of compounding interest. You need to have something other than your home as an asset base.
Option four — invest a lump sum: As you can see from the calculations the growth on a lump sum could be far higher than investing every month (the lump sum would have had longer to grow). However there are risks.
Unlike investing monthly, you are effectively timing the market by investing with a lump sum. The market is looking fairly expensive at the moment and what with the drama unfolding in North Africa, stock markets are likely to be volatile.
If the market falls again within the next year this will impact your longer-term returns. A monthly investment tends to result in more constant returns.
Also by investing the lump sum into your mortgage you are reducing your debt, which gives you flexibility if you run into financial difficulty in the future. You can always stop your investments if you have to, but you always have to pay the bank!
Whatever you decide, make sure you save any additional income you have as a result of either the rental or sale of the property so that you can build up your long-term wealth.
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