Your mortgage bond: friend or foe?
CAPE TOWN - There’s nothing like home sweet home, and it’s your own. You’re not at the mercy of a landlord who may increase rental payments by more than the inflation rate or decide to sell and give you notice to move out.
Paying off the mortgage on your home means that you’re contributing towards equity that will be yours.
One of the biggest decisions you may face in search of financial security is whether to pay off your mortgage sooner rather than later. This may be either in its entirety if you’ve had a big business win or received an excellent bonus, or by increasing your monthly repayments, to pay it off faster. The decision can be complex, involving the returns on your investments, the interest rate on the mortgage, inflation and, significantly, human emotion. Before you call your bank manager with a decision, you need to consider the pros and cons.
Advantages of having a mortgage bond
Owning a home – and keeping up your monthly mortgage payments – is a sign of stability. If you need a loan for other reasons, such as buying a car or investing in a business, the first thing lenders will probably look at is whether you own a home and whether the payments on your bond are up to date. It demonstrates that you can manage credit and are unlikely to default on your payments.
Then there’s the human factor. If you’re by nature a spender and more likely to buy a new set of golf clubs or jet overseas than to redirect what you would have paid on your mortgage into investments such as a retirement annuity or unit trusts, there’s a definite advantage to having a mortgage. It’s a forced saving.
A big advantage is that a mortgage lets you benefit from the lowest interest rate available, based on the security of the value of your home. It’s inexpensive debt and the portion of it you have paid off can be accessed to, for example, do renovations to your home.
Disadvantages of having a mortgage
There’s no point to being home rich and cash poor. Life can become very stressful when budgets are tight and you’re faced with unexpected and significant expenses. Ongoing mortgage payments may prevent you from setting up a crucial cash fund for the inevitable emergencies.
Then there is what is known opportunity cost, which is the cost of missed opportunities in other investments. If you’re paying off a mortgage, you risk losing out on potential gains you might be making by investing elsewhere with returns greater than the interest rate of your mortgage. But you do need to consider the after- tax return on the investment and risk associated with it: the opportunity cost is not guaranteed in volatile markets.
The good old policy of diversification also applies. If you’re home rich, cash poor, and not investing in other asset classes such as equities, you’re bearing significant risk in your investment portfolio in that it’s overweight in property. This risk is exacerbated the closer you approach retirement.
The most significant reason to pay off your mortgage is the saving on interest. If you borrow R3 million at a nine-percent interest rate and pay it off over 25 years, your monthly payments will be R25 176. The interest cost included in these payments over the 25 years amounts to a staggering figure of over R4.5 million.
And finally, your mortgage could cost you peace of mind which you may experience when debt-free.
Like life, personal financial planning involves a series of trade-offs, so there is no right answer for everyone. The decision should consider all personal variables, including all your assets and liabilities, risk profile, family circumstances and age. Discuss your set of circumstances and priorities with your financial adviser before making this important decision.
Linda Graham, who has the Certified Financial Planner accreditation, is the founder of FinCommunication, a marketing consultancy for financial services.
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