Advice to bond applicants

With the interest rates at their lowest levels for some 30 years (the nearest we have recently come to the current levels was in April 2005 when the rate was 10.5%), home buying looks very attractive - and, says his group is witnessing a much stronger demand and a renewed willingness to consider homeownership.

But there is a serious danger here: many buyers will assume that the current low rates will be maintained for a long time and, thinking this way, they may easily over-commit themselves on their bond payments, only to find that when rates do rise "as they inevitably will", they are in trouble.

If one thing in financial circles can be predicted with absolute certainty, it is that today's very favourable rates will not last forever.

One has only to look at the interest rate's recent performance to understand how regularly changes occur - since 1990 the rate has changed 63 times. Even more significantly, the average rate over that period was 16.4% - approximately 7% higher than the current rate.

Two or three years from now interest rates could easily be at 14 or 15% again.

While it is true that financial cycles never follow exactly the same patterns as before, it is also true that they do occur.

So if you are an eager buyer now making plans to become a homeowner assuming that you qualify for a bond our advice is to pitch the bond application as if the rate will soon be 13.5%, ie, apply for a bond roughly 20% below the maximum value which the bondholder could now be given. The applicant can work this out with a good estate agent or mortgage originator - let him just make sure that, if and when rates rise, he will not have a problem.

For example, supposing the bond applicant has a sound credit track record and is a steady salaried employee earning ±R40 000 per month, he might qualify for a bond of R1m- but we would suggest that he applies for a bond of R800 000. If this means that he has to opt for a less prestigious area or a similar, less luxurious home, so be it. He can upgrade later.

This is infinitely preferable to finding when rates rise that the higher payments are causing distress.

Just how significant future interest rises could be can be seen from the fact that at current rates a R800 000 bond would cost R7 546 monthly. If and when the rates do rise to 13.5% this monthly payment would rise to R9 656 - an increase of over R2 000 per month.

If at all possible while rates are low, the bondholder should pay above the stipulated monthly rate and thereby shorten the payoff period and build up a savings nest egg.

Even a few extra hundred rand paid each month will shorten the payback period by years - and it will also reduce the time before an upgrade is possible.

Article by: Tony Clarke -