Those who took full advantage of the banks’ willingness to extend credit on mortgage bonds should embrace the lower interest rate and get their home finance back on the straight and narrow.
In the good old days, you raised a bond, bought a home and paid it off within the 20 year repayment period. Then someone had the brilliant idea of allowing homeowners to tap into their bonds to raise finance for boats, cars, furniture or in fact, anything that they wanted.
On the face of it, using your bond to finance other ‘necessities’ seems ideal. Bond finance traditionally offers a much lower interest rate, particularly when compared to vehicle finance, personal loans and overdraft facilities. There are however a number of drawbacks which, once the economy turned, left many South African homeowners high and dry, struggling to pay off the inflated amounts on their mortgage bonds.
Before you all start harbouring ill feelings towards your bank manager, it pays to remember that South African banks weren’t the only ones that virtually threw credit at their customers. At one stage in the US, you could buy a home and finance it well below the prime rate, furnish the property and park a brand new vehicle in the garage, all on the strength of bond finance. The situation eventually got totally out of hand. Many found that they were drowning in debt, and once the sub-prime period had expired and home owners were forced to pay higher rates, they had no way of repaying the massive debts they had incurred.
Once the rot had set in, it quickly became clear that bonds at far too favourable rates had proved disastrous for American homeowners and the banks that financed them. In 2010, it was reported that some 279 banks in the US had collapsed and in a report that was published in the Wall Street Journal, it was noted that investigations into the demise of these banks indicated that the number of defaulters on real estate mortgages was the primary cause of the failures.
The ensuing crisis affected property markets all around the world, leading banks which had emerged relatively unscathed to rethink their lending policies. However, things were about to get interesting for homeowners who had been caught up in the credit fiasco and who were now financing inflated bonds.
Although it has been some time since the recession and subsequent credit crunch hit South Africa, there are undoubtedly many people who are still servicing inflated first and second bonds. This, of course, isn’t a problem if the homeowner plans to stay in the property for a relatively long period and can afford to pay the inflated amount. The problems only really start coming in when they need to sell the property and cannot afford to lower the selling price because the property is bonded to the hilt.
It is one thing to sell a home and make less profit, it is quite another to sell a property and still be held liable for an excess amount.
It is of course highly advisable to pay off as much of your bond as quickly as possible and, given that the interest rate has dropped once again, this could be the perfect opportunity to get serious about the amount outstanding on your bond. There are many financial advantages to paying off a bond in a shorter period, but, when bonds have been used to finance other things, a rate cut can literally be seen as a Godsend.
As with any debt, a mortgage bond needs to be managed extremely carefully. Now may well be the time to put as much money as you can into your bond, particularly if you are still paying off a vehicle or similar high end purchase, and bring your bond financial obligations down to more realistic levels.