YOUR MONEY: What’s the deal with the 20-year home loan?

This week, an FM reader asks whether there are any workable ideas for paying off a bond in a shorter time than the usual 20 years.

Answer:

Paying off a bond in less than 20 years is always a good idea. This is especially relevant in the rising interest rate environment we’re now in. To pay the bond off faster requires that the reader increase their monthly instalment. Paying in a little extra from the start can save a property owner a lot of money over the repayment period. The figures below, sourced from the FNB home loan calculator, show the potential savings for a home loan with an 8.25% interest rate.

The savings get bigger the higher the interest rate — in other words, an extra R500 payment on a loan charging 9.25% interest saves R31,563 more than a loan charging 8.25%. It’s pretty straightforward maths.

The more interesting question is: should you try to settle your home loan in a shorter period? Our view is yes, but … Yes, to the extent that you have additional cash flow available, but only if your personal balance sheet allows you to.

Ideally you should pay off a home loan with inflation. A home loan is long-term debt, so you get to benefit from inflation. Simply inflate away the debt over time. Your income is likely to grow by inflation over the years, but your bond repayments will fluctuate with interest rates. And there is a compounding effect on your income, but not on your repayments. After 10 years the instalment on the loan is likely to be a lot lower as a percentage of your income than when you took out the loan. Mine went from more than 40% to below 15% of my income over 12 years.

But as discretionary income becomes available, how much should you allocate to additional home loan repayments? Our view is that your personal balance sheet should guide you. Settling a bond too quickly may mean that your balance sheet is dominated by a bulky, illiquid asset that does not generate income — your home.

Rather, a strong balance sheet has diversity (different types of assets like property, unit trusts, shares, offshore investments and so forth), liquidity (for life’s unforeseen events), good growth prospects and low concentration risk. If the reader’s balance sheet is strong enough, by all means they can increase their instalments and settle the home loan faster. If not, they should focus on building a strong balance sheet first.

— Craig Gradidge (CFP) is co-founder of Gradidge-Mahura Investments 

Send us your questions to yourmoney@fm.co.za