There has been a spike in unsecured lending in recent years because many people go this route to meet their borrowing needs. But a home loan, if you have one, is the cheapest, most flexible way of borrowing money, Praven Subbramoney, head of product and sales at First National Bank (FNB), says.
A home loan is relatively cheap because it is a secured loan and the risk to the borrower is reduced by the security that immovable property offers. Home loans attract lower interest rates than unsecured debt (see “Maximum interest rates”, by clicking on link below).
For this reason, a home loan can be a useful debt instrument, but only if it is used wisely, especially if you are using it to pay off short-term debt. Subbramoney says you need to be disciplined and exercise “responsible debt management”.
Given the flexibility of a home loan, it may be used for funding other assets, debt consolidation and saving.
“Equity” in your home loan is the difference between the market value of your property and the outstanding amount on your bond. It can also refer to the difference between the registered bond amount and the outstanding balance – in other words, the capital you have repaid.
You can also have negative equity, which is when the amount you owe exceeds the value of the property, usually following a fall in the property market.
To fund assets using your home loan, you can usually do so with “pre-paid” funds: any extra cash that you’ve put in your loan. Many people stash surplus cash – such as their annual bonuses – in their home loan for this very purpose.
Note that there is a difference between pre-paid funds and repaid capital. The banks are more stringent about giving you access to repaid capital, and will subject you to an application process to ensure that you can afford what is essentially a re-advance.
Accessing money you have paid in excess of your monthly instalments is allowed, provided you have an “access facility”. Usually, the only condition to being granted such a facility is that you open a transactional account with the bank that has given you the home loan. This is for ease of transferring funds in and out of the home loan account.
Once you have access to funds in your home loan account, you could tap into it to cover expenses such as your children’s education or holidays, instead of through more costly short-term debt.
Debt Consolidation
A home loan can also be used to consolidate your other debts, and significantly reduce the total interest you pay.
Short-term or revolving credit – such as personal loans, credit and store cards – attracts higher interest rates, in line with the higher risks these types of credit pose to borrowers. For example, the interest charged on vehicle finance is typically prime plus three percent, and the maximum interest due on credit facilities such as credit cards is 22.1 percent.
Assume you have short-term debt of R130 000: R100 000 owing on a car, R10 000 owing on a fridge and R20 000 in credit card and store card debt. You could be paying 13 percent interest on your vehicle repayments and 22.1 percent for the fridge, credit card and store debts.
If you have sufficient equity in your home loan, your bank may advance you the money, enabling you to settle all of your debt and pay it back at a more favourable interest rate.
Subbramoney says FNB cautions customers against consolidating debt and subsequently acquiring more short-term debt.
“Consolidating debt should create additional disposable income, which should be used to extinguish debt sooner rather than to finance more debt or lifestyle expenses,” he says.
When using available funds in your home loan to fund other assets or to consolidate debt, the essential thing to remember is that the longer you take to pay off the debt, the more it will cost you – even at a more favourable interest rate. Your goal must never cease to be the early elimination of debt.
Many consumers get this wrong and inadvertently end up paying more than they would have had to do if they not used their home loans. This can easily happen if you stretch the repayment of short-term debt or debt covering depreciating assets (such as a vehicle) over the long term. When you do this, the costs far outweigh the benefits.
If you use your bond to finance a car, pay it off in five years or less. And if you use it to fund tertiary education, pay it off over the same number of years that your child is a student.
Steven Barker, head of home loans at Standard Bank, cautions: “[Using your home loan as a debt instrument] takes financial discipline. Be careful you don’t shoot yourself in the foot doing this.”
On the flip side, he says he has seen people use the equity in their home loans to start businesses.
Carel Gronum, head of home loans at Absa, says: “It is strongly recommended to customers who finance vehicles and other big-ticket items through a mortgage loan that the amount extracted be repaid over the shortest possible period.”
The key message with any debt, Barker says, is: “Get rid of it as soon as you can”.
Timothy Akinnusi, the head of sales and customer value management for home loans at Nedbank, says the bank does not encourage the use of home loans “as a cheap or alternative source of funding”.
He says if clients want to apply for a re-advance, they won’t be required to register a new loan, but “decisions to release the funds are subject to Nedbank’s valuation and credit lending criteria”.
Using your loan to save
Any surplus funds deposited into a home loan will perform better than most deposits in a savings account, which typically attract a lower rate of interest, Subbramoney says.
“As an alternative to opening a savings account and earning interest on the balance, you, as a borrower, will pay less ‘net’ interest (interest paid minus interest received) if you deposit the money in your home loan. This is similar to receiving your home loan interest rate on your savings account,” he says.
Subbramoney says you may also avoid paying income tax on the interest you earn, although you would have to earn more than R32 800 a year in interest from all your investments for this to apply.
For example, he says that if you put R100 000 into a money market account with an interest rate of 3.4 percent a year, the income generated, excluding fees, will be R3 453. This may attract income tax, depending on what other investments you have. Whereas, if you deposit the R100 000 into your home loan account (with an interest rate of 8.5 percent), you will make a tax-free saving of R8 800 a year.
You can also make substantial interest savings by paying as little as R100 extra into your home loan account every month. Subbramoney says that if you boost your monthly repayments by 10 percent a month, you can take years off your loan term. For example, if, assuming an interest rate of nine percent, your home loan is R1 million over 20 years and you pay 10 percent extra every month from inception, you will save R281 000. The term of the loan will decrease to 15 years and 10 months.
Barker says not enough people pay more than their instalment into their home loan.
“About 80 percent of [our home loan] clients pay only what they have to pay. Paying more than the minimum reduces the bank’s profitability, but it allows the consumer to lend against their property when they need to. The message is so powerful: every time your salary increases, increase your instalment by that percentage and experience the benefit over time,” he says.
Cancelling a bond will cost you
*Paid-up loans
Paying off your home loan before the end of the term is a major milestone, but it does not mean that the bond is cancelled, Praven Subbramoney, head of product and sales at First National Bank, says. “If you would like to be in possession of the title deed, the bond must be cancelled in the Deeds Office, and there is a cost associated with the cancellation of a bond. The cost is payable by you to the attorney appointed [by the bank] to cancel it.”
Some customers keep their home loan account open after the debt has been paid in full in order to run their homeowner’s insurance premiums through the account. “This is not necessary and, in the long run, costs you in monthly service fees,” he says. “You can redirect the insurance premiums to your transactional account.”
However, the real decision should be whether you think you might still need access to funds from your home loan. You may decide to leave your home loan account open in case you want access to cheap credit, or to do home renovations at some point, and you want to avoid the cost of having to register another bond. While this makes sense, understand that keeping the bond account open will also come at a cost.
“Should you no longer need access to funds from your home loan account, we recommend you cancel the loan, because you will continue to be liable for a monthly service fee, until the bond is cancelled in the Deeds Office.”
*Matured loans
A matured home loan is one that has reached maturity, and this, too, incurs cancellation costs, Subbramoney says. “When the loan has matured, you will be required to cancel the bond in the Deeds Office to obtain possession of your title deed. The normal bond cancellation process must be followed.”
Savings tip
An easy way to save on interest in your home loan is to change the debit order date to the day you get paid, Praven Subbramoney, the head of product and sales at First National Bank, says. “Interest on home loans is charged daily, so the earlier you reduce your balance, the less interest you end up paying in total. This movement is very small on a monthly basis, but compound interest makes this small change valuable over the term of the loan and is a great way to save on total interest paid.”
Steven Barker, head of home loans at Standard Bank, says it is definitely worth aligning your debit order with your pay day. “A home loan is a big debt and the sooner you pay it, the bigger the saving. Just be very careful that you don't set your debit order too early, because then you will incur penalty fees for a failed debit order, and these fees are steep.”