How can debt in form be a good thing? This is a common question when faced with debt but acquiring debt can certainly be a very good tool with tax benefits under certain circumstances that can help propel your investment strategy forward and afford you the opportunity to use the banks money to grow your wealth.
Living debt free certainly provides you with peace of mind but it is important to consider which debt to be free from and which debt can be used to further improve your financial position. In it’s essence, relieving yourself of debt on high interest debt like credit cards and personal loans or any debt on depreciating assets like cars and appliances that are financed.
Debt on appreciating assets on the other hand is a completely different animal offering you the opportunity to grow your asset base and increase your wealth. The best way to illustrate this is through a comparison of different circumstances surrounding property purchases.
Let us assume that there are 2 individuals, each with R1 million to invest in property. The first buys a property for R1 million and enjoys it debt free. The second takes the R1 million and uses it to buy four R1 million properties, each with a deposit of R250 000, leaving him with 4 bonds totalling R3 million.
Now we need to consider the value of these properties over a period of 10 years, which according to the PPI(property price index) for the past 10 years is close to 200% giving us a value of around R3 million for the property that was purchased for R1 million 10 years ago.
Let us compare the results assuming that the person who bought the 4 properties still has the R1 million in cumulative bonds and has only serviced the interest portion over the 10 year period.
Person 1 has a property worth R3 million less his R1 million input and he has made R2 million.
Person 2 has 4 properties worth R3 million totalling R12 million but still has bonds totalling R1 million leaving him with R11 million in assets. He would have paid around R1.4million in interest and assuming there was no income generated through rentals, leaving him with a net investment value of R9.6 million. If of course there was a rental income, this figure would be dramatically different again.
This clearly illustrates that with the wise use of debt one can significantly grow ones wealth.
Your bond is an important tool that can allow you to achieve your financial goals quicker if used in the correct wealth generation manner.
Clever use of the equity available in your home loan can prove to be a very valuable wealth generation tool and here are a few ways in which best to use that home loan equity.
By using the equity in your home loan to purchase a vehicle, you could be saving as much as 4% in interest payments but it is important to pay the instalment amount as if you had financed the vehicle at the higher rate over a shorter period. By doing it this way you are saving a lot of money on your vehicle purchase but, if you do not pay what would have been the car payment it will end up costing you a whole lot more. Discipline is the key here, do not use you bond to make a vehicle affordable over the period of your bond.
In a similar fashion, by using the equity in your bond to repay credit card debt and paying the usual credit card payment amount directly into your bond you will again be saving a lot of interest. Credit cards attract the highest interest rate of most short term lending so it is important to be very careful with your credit card once the debt has been paid off from your bond. Never over extend yourself again on your card, only use the amount you are able to pay in full at the end of every month and pay the debt reduction instalment directly into your bond and you will again be saving a large sum of money in interest payment.
By increasing the excesses on your home and vehicle insurance you can dramatically reduce your premiums and in the event of a claim, you could easily withdraw money from your bond to finance the excess if required. The key to this strategy is to ensure that you drive carefully and live in a secure manner. Insurance is meant to be for unusual happenings but today it is often seen by people as an item replacement option, hence the high instances of insurance fraud in South Africa. Drive a little slower, never drive drunk and be vigilant around your home and you will save yourself a fortune in insurance payments with this strategy.
Make it your goal to repay your loans as quickly as possible to reduce interest amounts and ensure that you are well versed in the early settlement penalties that some institutions put on early settlement.
One thing to be very aware of is that South African banks require that in order to settle your home loan before the end of the term you as the bond holder are required to give them 3 months notice of settlement. By way of example, if you are selling your home, you must give the bank written notice of your intention to settle your home loan 3 months before the expected settlement date. If you do not settle the home loan in the 3 month period you are again required to give notice of home loan settlement. Never assume anything when it come to South African banks, call your bankers and get the answers before you do anything out of the ordinary, it could save you a lot of money.
Fixing the interest rate on your bond is something to consider for those who really need to be able to budget or for the risk averse. It is generally not a good idea to fix your bond rate even if one considers that the bond rate is bottoming out and we are likely to enter an increase cycle.
The reason is that in order to fix your bond you will need to pay around 4% above the current bond rate which could be fixed for a maximum of 10 years but more likely 3 to 5 years. It is very unlikely that the bond rate will increase by that amount in a short period of time.
The bond rate has only been above 14% for a little over 12 months in the last 10 years(see rates below)
When we think about, the banks are in the business to make money and any product they offer is intended to either make them money immediately or to retain you as a client. By fixing your bond rate the banks are achieving both of these goals, they are making a hefty 4% (granted it’s a calculated risk in times of uncertainty) on you for the peace of mind of being able to budget.
User the bond calculator to see what the effect on your interest payment will be over a 5 or 10 year period, also do the calculation of how much you could reduce your period over if ypou paid the additional amount into your bond over that period. It is quite incredible what it costs in the long term. If this does not sway you away from fixing your bond, then go ahead and see what period and at what rate your bank will fix your bond at.
The extra money you pay into your bond being the difference between your present rate and the premium for fixing is very likely to save you a whole lot of cash unless there is a total meltdown and interest rates rise at unprecedented intervals, so think very carefully before you take this leap.
You see your dream home at a price you can afford, the repayments are within budget and you are ready to sign on the dotted line. Be aware of the costs involved when buying a home.
There are a myriad of costs involved to home ownership that you should be aware of upfront and make allowances for. Have the cash available to deal with these costs as most are payable up front to your transferring attorneys or bank and could get you into hot water if you have signed an offer to purchase without making allowance for them.
- Bond registration costs
- Transfer duties
- Conveyancing fees
- Deeds office fees
- Rates and taxes
- Banks charges
- Home owners insurance
- Life insurance
A typical home purchase of around R1 million would amount to about 7% of the purchase price excluding the deposit. Deposits can vary from 0% to as much as 30% depending on the property and your credit rating.
Other costs to consider
- Moving costs
- Water, rates, and electricity
Moving into a new home has many additional and ongoing costs to consider. The likelihood is that you are moving to a larger home or a home with a garden or in a better area. Make sure you know what the rates are, they are different for every area and dependent on the size of the property and many other factors.
If you now have a garden you will need a lawnmower, use a lot more water, have additional security costs like armed response or electric fencing or both. These can amount to over R1000 a month and lets not forget what it costs to maintain an electric fence or automated gate.
Be aware of every possible additional cost going forward. Ask the real estate agent for all of the information about the average rates and taxes, water consumption and the prominent security services in the area. Call the security company and find out what the monthly costs are. DO THE RESEARCH, buying a home is a long term investment.