Should you pay of your bond or invest?
DURBAN - We intrinsically know that paying off a bond as soon as possible is a good thing but how does it compare with other alternatives to building a long-term nest egg?
So says Gareth Bailey, Pam Golding Properties area principal for Durban Coastal, referencing an article by Hereford Group and Alexander Forbes.
"The obvious and main benefit of paying off your bond early is that it saves you the cost of interest, which can be considerable," said Bailey.
He added that by paying an amount in addition to the minimum monthly instalment, you pay off the capital portion sooner, which reduces the term of the loan and hence reduces the total amount of interest paid.
According to Bailey, whether you earn interest on savings, earn a return on an investment or save interest on debt, the benefit is the same. Importantly, the interest saving by paying off your bond early is tax-free in that you don’t get taxed on the interest you have saved.
For your primary residence, this is advantageous because the interest is not tax-deductible, whereas with buy-to-let property it is.”
Bailey said that another benefit of paying more into your bond early is that you accumulate a saving that can usually be accessed on a rainy day.
Many people are most aware of their desire to pay off their bond when interest rates are high as opposed to when interest rates are low and it is easier for them to meet their minimum monthly instalments.
Financially, this is counter-intuitive as it is easier to get ahead with paying down the capital balance when interest rates are low, as more money is going toward paying capital than interest.
To reap a better reward, one should be disciplined and maintain additional payments throughout the interest rate cycle.”
Pointing out that there are multiple benefits to paying off your bond early, Bailey poses the question as to how this compares with just paying the minimum monthly bond instalment and paying an additional monthly amount into, for example, a unit trust.”
Equity returns are very volatile over a five-year term but are generally quite favourable and stable over longer periods of time. For example, the Coronation Balanced Plus Fund yielded a return of 8.3% over the last five years, 11.4% over the last 10 years and 15.5% over the last 15 years.
Although the past does not guarantee the future, if paying extra into your bond is going to reduce the term to between 15 and 20 years, then you may be better off investing in equities and exploring the higher potential it offers over the long-term.
Bailey said that while some people advocate paying off your bond as a priority and others prefer investing in equities, ultimately, you can’t go far wrong with either approach and you are likely to have a nice lump sum upon retirement.