Making your bond work for you: Spend the savings or pay down the debt?
By Lauren Davids
Interest rates in South Africa are the lowest they have been in around 50 years, providing some heavily indebted households the rare opportunity to reduce debt without increasing monthly payments.
Reuben and Sandra are an example of a working-class couple who have decided to keep their bond repayments at pre-crisis levels and “make a dent in what they owe the bank”, rather than spending the extra cash that would otherwise be available to them.
“We could really do with a little extra cash but at the end of the day we probably would have nothing much to show for it,” says Sandra. “On the other hand, paying off a little of our mortgage will mean a big saving on interest over the long-term, and will hopefully mean we can pay off our home loan earlier.”
The 41-year-old office worker and mother of two has been lucky enough to hold on to her job during the Covid-19 pandemic and the lockdown, as has her husband, who works as a communications manager in a financial services company.
They owe the bank just less than R1 million on their 3-bedroom home in Claremont in Cape Town. Their monthly repayment on their 20-year bond was R9 650 at the beginning of the year. Over the past few months it has come down each time the prime interest rate has dropped, and is now R7 752 a month.
Sandra says it would be lovely to use the extra money – a monthly saving of R1 898 – on a few items of clothing and some luxury groceries and household goods, but she feels that paying down their mortgage creates a gift that will keep giving since every rand that is paid towards the capital of the loan will not cost them interest for the next 16 years (the term left on their loan).
This is true not just for home loans, but for other forms of consumer debt. The interest rate charged on home loans and other credit facilities, which varies according to the borrowers’ circumstances, is typically linked to the prime rate.
People with credit card debt, or car or furniture financing loans, will be facing the same choice: spend the saving or pay down that debt and save yourself a lot of interest in the long run. Interest payments on debt adds up and compounds over time into a large chunk of money over the years.
Other options to turn that monthly saving on your bond or other debts into more than some rands and cents would be to build up an emergency fund for the household. A good place to keep this fund is in a unit trust, which provides one with liquidity.
It is difficult to put a price tag on the peace of mind one gets from knowing that an unforeseen event or unexpected expense – such as a doctor’s bill, a leaking roof or a car breakdown – can be covered easily without blowing the bank or taking on more debt.
Another way to reduce your bond and other loans is to make additional contributions to your retirement savings and claim back some of the tax you have already paid. You can claim back tax you have paid on money you invest for your retirement up to 27.5% of your earnings (with a maximum of R350 000).
In other words, if Reuben and Sandra put that extra almost R2 000 a month into a retirement savings fund they could claim the tax they have paid on the equivalent amount back from SARS at tax return time. In addition to generating a tax saving within a year, their investment would continue to grow over the years to retirement. Some retirement fund providers, such as 10X Investments, allow retirement savers the flexibility to increase and decrease contributions as required without any penalties or additional costs.
A tax refund is calculated by multiplying your total contribution for the year by your marginal tax rate. For example, an additional contribution of R24 000 a year (imagining you could save an additional R2 000 a month) for a person who is paying a marginal rate of 31% gives a refund of R7 440. A saving of R60 000 over the year (R5 000 a month) at a marginal tax rate of 41% would mean tax back of R24 600.
Lauren Davids is a Senior Investment Consultant at 10X Investments.