JOHANNESBURG — My colleague Felicity Duncan recently moved from a 150 square metre house to a 75 square metre flat. She thought she’d feel deprived in the smaller space but said there’s not much difference in her daily experience. And research backs this up, arguing that we don’t really need as much space as we think. Stealthy Wealthy, a blogger targeting financial freedom in 15 years, applies a similar thought process when buying a house. He argues that we generally try max out on our bonds, and get the most one’s salary will allow. But by downsizing the bond from the outset, one can shave years off the length of the home loan, by putting the difference saved back into the bond. A little pre-planning could go a long way, given it’s the biggest investment you’re likely to make. – Stuart Lowman
This is not an article about finding an extra couple of hundred bucks and putting it into your bond each month. It is not about moving your debit order from the 1st to the 25th, or putting half your annual bonus into your home loan. And it also has nothing to do with allocating a portion of your annual increase towards your bond each year.
Make absolutely no mistake, all that definitely helps. But shaving years off your home loan, and hundreds of thousands off your interest bill, can actually be a lot easier than that, and it starts a lot sooner than when you sign up for a bond.
This article is about a concept which can be applied to almost every purchasing decision, but it’s impact is probably best illustrated when it comes to buying a property – due to the relatively large purchase price combined with debt financing. This article is about buying according to your needs, and not according to your affordability.
Let’s start by checking how a typical person might go about a property purchase.
Meet Peter. Peter has just got a promotion and he has decided that it is time to buy a house in an area which is close to his work.
So the first question Peter asks himself is how much can he can afford to allocate towards a bond payment each month? He checks his budget, moves some stuff around, deducts the amount he is currently paying for rent, and comes up with R9 650/month. Next Peter uses one of those online calculators to figure out what size bond he could qualify for – and would you look at that, based on his income and the R9 650/month he can afford, he can get a bond for exactly R1 million at prime (10%) over 20 years. (At this point. he may also approach some of the banks and try get a pre-qualification amount to make sure he will get approved for finance once he signs his offer to purchase.)
Peter then takes this R1 million and combines it with his deposit amount to determine the purchase price he can afford. From there he starts looking at houses in the areas he likes, priced at this amount (or, in truth, he probably considers properties priced a little higher knowing you can usually talk the seller’s down a little bit).
In other words, Peter goes about things the way a lot of people do – they buy a house for the maximum that they can afford.
Now consider if Peter instead decided to buy a house for just a little bit below what he could actually afford. Let’s say this results in a bond that is 10% less than what he qualifies for – i.e. he takes a bond for R900 000 instead of R1 million.
Peter’s bond payment would now be R8 685 a month. But since Peter could afford R9 650 a month, and he had ear-marked the full R9 650 for the bond, he decides to take the R965 saving, and put it into his bond as an extra payment every month.
By doing this he will pay off his house in just 15 years. A mere 10% reduction in the bond amount saves him 25% of the loan duration. And best of all, this doesn’t require any scraping additional money together, getting creative with debit order dates, or being disciplined with annual bonuses! (But imagine if you did all that too).
Seems like a really easy way to pay off a house in 15 years?
And now, to take it to the next level, let’s say Peter takes a bond for 20% less than what he could afford (R800 000 loan at 10% = R7 720/month) and put the savings (R1 930) back into his home loan. By doing this he could pay off his house in less than 12 years.
A 20% reduction in the loan, results in a 40% reduction in the loan duration. Pretty powerful stuff.
To summarise, the table below shows the loan duration for various home loan amounts for Peter, who can afford a R1 million bond.
And this same calculation applies for all home loan amounts. The table below shows the general case for a home loan at prime (10%) over 20 years and how long it will take you to pay off a house if you took a bond for less than what you could afford, and then put the difference in as extra payments.
Want to pay off your house in 15 years? It’s easy, take a bond for 10% less than what you can afford. Want your home loan squashed in 12 years? No problem, take a bond for 20% less than what you can afford.
Obviously, all this assumes that you will have the discipline to put the savings from the reduced loan amount back into the bond each and every month – which is of course easier said than done. So to avoid the temptation, you could set up a monthly scheduled payment which goes off every month the same day as your bond repayment – in that way you will forget the “extra money” even existed, and won’t even miss it.
And finally, don’t forget about the other advantages of buying for less than what you can afford:
- If there are sudden interest rates increases, you have some wiggle room to manage it. By buying for the most you can afford, and stretching yourself to the limit, you could find yourself in a very uncomfortable situation should interest rates go up. Worst case, you may even have your house repossessed.
- A cheaper property generally means lower associated costs – like lower insurance, lower levies, and lower rates and taxes.
- The smaller the home loan amount, the more chance of you getting approved by more banks, which means you have a better shot at getting a lower interest rate – imagine if you put the additional interest rate savings into your home loan as well.
Needless to say, all this is of little use to those of you who are already paying off a bond, but for those who have yet to take the home ownership plunge, hopefully you will keep this article in mind when the time comes…
- Stealthy Wealth runs a personal finance blog documenting a 15 year journey to financial freedom.