Investing in your bond is best in rising rate environment

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 your 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.

"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 period 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 R 7617.14 per month. Now let's say this person decided to pay an extra R1000 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 8 months.

"Now with rates 1% higher the monthly repayments are R8151.37. An extra R1000 means an interest saving of R353 144.58 and will reduce the outstanding bond term to 14 years 6 months.

"If rates rise another percent, the monthly repayment will rise to R8699.67. An extra R1000 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 4 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 R1000 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."

Hello ooba news

Financial freedom doesn't mean you have to win the lottery or a get an unexpected call from the executors of a long lost uncle's estate in Provence.

MortgageSA, South Africa's leading mortgage originator placing one in five mortgages, said that the possibility of a fixed mortgage system, currently being discussed by the Reserve Bank, could be a double-edged sword for consumers.

With stock markets in seesaw mode, the stability of property as an investment asset class has once again come to the fore. "House prices are expected to increase by 12% this year and while this may not be as high as in recent years, it still represents a good return" says Saul Geffen, Chief Executive of leading mortgage originator, MortgageSA.

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.

R 20 million for a three bedroom apartment in Cape Town's V&A waterfront may seem like a ridiculous sum to pay by South African standards, but it compares favorably with Sydney and remains significantly cheaper than upmarket apartments in other international playgrounds.