As interest rates rise, homeowners have an even bigger incentive to invest in their bonds, as they will be saving even more interest while benefiting from the secondary advantage of a shorter term of repayment.
Saul Geffen, chief executive of MortgageSA, South Africa’s leading mortgage originator, says that when interest rates rise, putting money into one’s bond guarantees a bigger interest saving.
”But while people understand this intuitively, they don’t realise paying extra sharply reduces the time it takes to repay a bond because the interest savings are so significant,” he says.
”It’s always a good idea to get bond free as soon as possible because of the amount of interest savings, and being able to live bond free is a sound financial goal. Of course, when rates rise as they are doing now, paying extra funds into your bond means you’re saving substantial amounts of interest.
”It’s also worth bearing in mind that in periods of rising interest rates, stock markets have historically tended to struggle, so putting any extra cash into a bond makes very good sense.”
As an example, on a house worth R800 000, let’s assume the owner was able to borrow at 1% below prime at 9,5%, before rates started to rise, and secured a 100% bond over 20 years.
”This would mean a monthly repayment of R7 617,14 per month. Now let’s say this person decided to pay an extra R1 000 a month into his bond. This would result in an interest saving of R301 251,17 and reduce the initial 20-year term to just over 14 years, eight months.
”Now, with rates 1% higher, the monthly repayments are R8 151.37. An extra R1 000 means an interest saving of R353 144,58 and will reduce the outstanding bond term to 14 years, six months.
”If rates rise another percent, the monthly repayment will rise to R8 699,67. An extra R1 000 in this rate environment means an interest saving of R408 137,72 and this reduces the bond term to 14 years and just less than four months.”
Geffen notes that these extra investments are not ”lost” as most people have access bonds and can withdraw these funds later should they really need them — ideally when interest rates are lower.
”Another way of looking at it is that the guaranteed after tax rate of return is now higher as rates rise. Going back to the example above, when you put an extra R1 000 into your bond, your borrowing rate is the return you’re getting. So, if you borrowed at 9,5%, you’re getting an after-tax effective return of 9,5%.
”If rates rise to 11,5%, that’s the effective return you’re getting and because it’s going into a bond, there is no tax to pay on it. So as rates rise, it’s relatively more attractive to invest in your bond than other asset classes.
”It also makes very good sense to invest in a property when you consider that property was the best-performing asset class over the last 20 years in South Africa and that Absa is expecting house prices to appreciate by 80% over the next five years.”