Are 30 year bonds worthwhile?
In an effort to lower their monthly bond repayment many prospective buyers might be looking at financing their bond over a period of 30 years. However, before they do so, it is best for potential buyers to carefully consider the financial impact of the additional interest charged over the longer term loan period. This is according to Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa, who recommends the more traditional 20 year bond to avoid unnecessary interest payments.
“Many would-be homeowners may look at a 30 year bond as an attractive option because the lower monthly repayment makes it seem more affordable from the onset. However, while the buyer will pay around 8.3% less on their bond each month, over a period of 30 years they will end up paying 64% more interest than they would on a 20 year bond term,” advises Goslett. “The savings on the monthly bond repayment is not enough to justify paying the massive amount of additional interest.”
He adds that home prices have seen an upward trajectory over the past few decades, while salaries have not followed suit. Getting into the property market has become more difficult for younger generations, which is why many buyers tend to choose a longer-term bond option. Affordability is an issue for many South Africans who are forced to find ways to cut down on repayments to get by; however it comes at a cost over the long term.
If a buyer purchases a home for R1 million at prime, which is currently 10.5%, on a 20 year bond term, their repayments will be R9 984. If the buyer makes no additional payments into their bond account and pays the minimum instalment over the 240 month term, they will pay back a total of R2 396 112, of which R1 396 112 is interest.
If the buyer purchased the same property over a 30 year bond term, their monthly bond repayment would be R9 147. Again, if they made no other payments other than the monthly instalments, they would paid back a total of R3 293 061. In this instance the interest paid is over the term of the loan is R896 949 more.
“If the money saved on the monthly repayment is used to pay off other short-term debt or is spent on an interest-bearing investment with a higher return than the additional interest paid on the longer bond term, it might be a worthwhile endeavour. However, if the money is spent on consumables each month, the buyer will be in a far worse financial position in the long run,” says Goslett. “Prospective buyers might be convinced to opt for a 30 year bond due to the perceived short-term gain, but the accumulative effect of the additional 10 year period should be carefully considered before any final decision is taken. It is imperative that the pros and cons are carefully weighed up and an informed decision is made.”
According to Goslett, if a buyer has purchased their home with a 30 year bond and their financial situation has changed, if they can afford to pay more into their bond they should. This will reduce the term of the loan and overall interest paid. “Regardless of the term of the loan, interest is only charged on the outstanding balance of the bond. Therefore if the buyer pays more than they are contractually required to, they will bring down the total amount of interest payable, simultaneously cutting time off the loan period,” Goslett explains.
He concludes by saying that there are very few situations where a longer-term loan would be financially beneficial. Therefore before buyers are enticed by a lower monthly repayment, they need to consider their long-term finance position.
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