South Africans are notoriously poor when it comes to a savings and investment culture and ironically very few people interrogate their single biggest “investment” – their bond or home-loan statement.
Consider that if one takes into account rates, water, electricity and bond insurance, then probably 30% of their monthly salary goes into servicing their home if they have a bond.
One of the oldest arguments around is whether or not your home is an asset or a liability. For those who view it as an asset, the most common logic is that you take out the largest possible bond you can afford and as your earning power increases, it will be easier to service the bond – particularly if property prices are rising faster than inflation.
Except that wages in South Africa have been stagnant in SA for the better part of a decade and property prices have failed to beat inflation on a regular basis (the Western Cape might be an exception but cost of living there creates an alternative form of inflation) and municipal rates and things like water and electricity have risen dramatically.
This graphic from the most recent Lightstone property report is fascinating and shows a calculation for house price inflation in each province.
Back to your home-loan statement
Assuming they are paying the prescribed minimum balance, very few people know that for the first 4 to 5 YEARS of servicing a bond, they are effectively only paying the interest on their debt. Let that sink in for a moment – you need to generate roughly 30% of your salary for 4 – 5 years before you start to pay down the debt on your house.
Let me use an example of a property I have which has – until recently – had tenants in it. The bond is for R950 000 and I’ve been diligently servicing it for 8 years now. The monthly instalment is R9700 and like clockwork, it goes off on the 25th of the month.
8 years x 12 months * R9 700 = …. R931 200 which has been paid into this bond. The amount outstanding is … R753 000.
“That’s crazy!” I hear you say … no … that is the impact of compound interest working against you.
So let’s go back to the bond statement to understand what happens every month.
As mentioned, the monthly instalment is R9700.
In January (A 31 day month**), the bank charges R6591 of interest on the outstanding loan amount. On top of that there is a service fee of R57 and an insurance premium of R633.79. This means that of the R9700 I pay every month, only R2418 is going to servicing the outstanding amount on the bond. Put differently, only 25% (a quarter of your repayment) is going to paying down the debt amount.
** It is very important tor remember that interest is calculated daily on a home-loan.
Two sides of the equation
I have always focused on the investment side of the equation but at a time when equity markets are not delivering returns and asset prices are not rising, it is imperative that we remember that there are 2 sides of the equation: Investment returns and cost of servicing debt.
I can – to some degree – control the cost of that debt by paying in more than I need on a monthly basis. I know that if I put an extra R1000 into that bond every month, I am eating into the capital outstanding amount on which I am being charged interest.
What the exercise does highlight is that I had the information in front of me in the form of a bond statement I receive every month. I only had to interrogate it to make a small tweak to my behaviours. But if I choose not to review and react to the information, I will continue to spend the cycle paying more interest than I have to.
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