What the banks don't want you to know
Millions of South Africans have bonds; too few realise they can save a fortune in interest, writes LEIGH ROBERTS
That's the view of Karl Posel, mathematics professor and author of five personal finance books.
Posel says more than eight million South Africans have bonds, but too few realise the banks are milking them dry.
Consider the following scenario: you have a R100 000 bond repayable over 20 years at an interest charge of 19.5% a year (assume this rate remains unchanged). After 10 years of monthly repayments of R1 660 (the amount the bank tells you to pay), you will have paid R199 200 in total.
Guess how much of your debt you have repaid after 10 years? A paltry R12 500. The remaining R186 700 has been nabbed by the bank as interest charges.
And the situation after 16 years is even more depressing - of your total repayments of R318 720, you have paid off only R45 000 of your debt, and still owe the bank R55 000.
This horrifying situation arises from the way in which a mortgage bond works. Briefly, you are charged interest at the end of each month and this is calculated on the outstanding bond amount. Each monthly repayment you make goes first to paying off this monthly interest charge; what's left goes towards reducing your debt.
In our example, R37.50 of the first repayment reduced the debt, and this increased to only R37.51 in the second repayment. As a rule, in the first half of a bond's term there will be only a minuscule decrease in the outstanding debt.
You can check how much (or rather how little) you have paid off on your own bond by referring to the first and second columns in the accompanying table. The second column gives your outstanding debt as a percentage of the original bond amount.
The table, compiled by Posel, applies to any bond amount at any time during the life of an original 20-year bond at an interest rate of 19.5% (the figures are even worse for higher interest rates).
"It's grossly unfair that the banks have never provided bondholders with this type of information," he says.
Posel says he took his book on the subject to his bank with the suggestion that it be issued to new bondholders - and was ushered out the door so fast it caused a draught! Bonds are lucrative business for banks.
However, there is a solution to the problem of paying never-ending interest on your bond: always pay more than the required monthly bond repayments. Try to increase your repayments by 5% to10%.
Your extra payments will directly reduce your debt, and a lower debt means a lower monthly interest charge, which in turn means more of your regular monthly repayments go towards reducing your debt.
In our example, if you paid 10% (that's R166) more than the repayment required by the bank each month, you would have paid off your bond after 11 years - nine years short of the original 20-year term.
"By paying only R166 more each month for 11 years (that's R21 912 in total), our bondholder has saved himself paying monthly repayments for the next nine years - a total of R179 280," says Posel. By spending R21 912, the bondholder has avoided paying R179 280.
And the higher your extra payment each month, the sooner you whittle away your debt. The third, fourth and fifth columns of the table show the percentage of outstanding debt over the period after extra monthly payments of 2%, 5% and 10%. The table shows that at an extra 2% you'll pay off your 20-year bond in 16 years, at 5% extra it will take 13 years and at 10% extra 11 years.
Posel has uncovered some other bond gems:
However, when you sign up for a new bond, opt for the 20-year period because this gives you a financial cushion as you can lower your monthly repayments if you fall on hard times.
This rate easily beats the after-tax interest rate you can earn on a fixed deposit and other bank savings accounts. So if your money is lying idle in a bank account, do yourself a favour and put it into your access-type bond.
Posel's findings are the subject of his book, Successful Retirement Planning, the Mortgage Bond Approach (Heinemanns). Top of page