The average home-owners in South Africa are a lot better off than they were a few years ago. The value of the property has doubled in the last five years. As discussed in previous articles, it is this extra 'wealth' that is helping drive the consumer boom.
This extra value that exists in your home, created by the difference between the market value of your home and what you owe, is called positive equity. This equity is also made up of the amount you have reduced your outstanding amount over the five year period. For example, if you purchased a home 5 years ago for R300 000 and it is valued at R600 000 today and you have reduced your outstanding bond to R250 000, you have R300 000 plus R50 000, or R350 000 worth of positive equity. Wow. That's a nice bonus, but what should you do with it? Firstly you should try and only use the equity created by the repayment and not the equity that exists because of the property appreciation. Don't go and take out a second bond just to finance your desired lifestyle.
Raiding the Piggy Bank
Treating your home might not be such a great idea. It is true that the interest rate offered by most home-loans is better than other forms of finance, e.g. the interest on your credit card(definitely) and your car(slightly). It seems logical that paying off your credit card with these excess funds is a good idea but only if you follow a few strict rules.
Credit Cards and store cards
Credit cards and store cards attract the highest interest. There is usually a 10% difference in the rate on these cards and your bond, or double the amount of interest every month. This should be the first debt that you eliminate, but only if you then don't go and run up the same 'freed-up' amount next month. If possible, cut up those credit cards if it is too tempting to use.
Don't fall into the trap of thinking that it also makes sense to pay for that new car out of the bond amount available. You're probably getting a 4-5% better rate on your bond so the interest is markedly different. Good idea. But put in place a mechanism whereby you pay the car off over the same time period that you would have paid off the car lease or HP. Even at today's great interest rate, you will still be paying 250% more interest if paid off over the life of a bond. That cheap R100 000 car can suddenly become that very expensive R250 000 car.
Using this positive equity to pay off debt is a good idea. Using it to pay for a holiday or any other consumable is NOT a good idea. Bad, bad idea. Do you really want to pay for that trip to the coast for the next 20 years because it seems cheaper?
Assets are the only things that you should consider using this equity for. An asset is anything that has a good chance of appreciating instead of depreciating over time. Use it to do that renovation or extension adding further equity. Even use it a cash loan to a business that you're starting. Treat yourself as a bank, but choose what you spend your money on very carefully.
Rather use the extra equity in your property to renegotiate a lower interest rate with your bank. Banks are willing to change your interest rate depending on your risk profile and this positive equity will work in your favour to get a lower rate. Make this a regular exercise.
If you do get an improved rate, use the difference in repayment to your advantage. Keep paying the same amount and reduce the length of your bond substantially. It is also a good idea to keep increasing your repayments every year to accelerate this repayment even further.
Article by: Dave Welmans - (www.thepropertygame.co.za)