Thanks, expertbeacon.com

So there was a recent opinion piece on moneyweb: How To Pay Your House Off In 7 Years.

A pretty broad claim was made:

1. Pay 10% extra each month;
2. Pay a constant percentage of your take-home salary; and
3. Make your payment on the 25th (when you get paid) rather than the 1st – because this could take a year and a half off your mortgage period*.
   *I am raising a HUGELY sceptical eyebrow at this one.

Do this, and you could pay off your house in 7 years.

This tip comes from this website: justonelap.com, where you find some disclaimers to said opinion:

1. It may mean that you need to buy a smaller home.
2. Increase your monthly repayments by 10% each year (rather than just by your salary increase), in addition to the 10% extra each month.
3. Keep your savings in your home loan in order to reduce interest (presumably, whatever savings are left, after all the extras).

Allow me to illustrate some compounding:

1. In year one, let’s say that your mortgage is R12,500 per month.
2. So instead, you pay R13,750 (up by that initial 10%).
3. By year 2, you’re up to R15,125
4. Year 3, R16,638…
5. And so on until year 7, where you’re up to R24,360. Nearly double what you had to pay initially.

So on the one hand – each additional Rand you put in is a contribution to capital, so you automatically save interest. On the other hand, are there better ways to use the money?

Anyway, here’s some modelling.

What does increasing the mortgage repayment by 10% each month and/or by 10% per year do to the loan period?

Here’s the way a mortgage works:

1. Each month, you pay back a portion of the initial capital.
2. The interest is calculated on the capital that’s left over.
3. Over time, with a fixed repayment, you’re paying progressively more capital, and progressively less interest.

So if you can accelerate the capital repayments, you do two things:

1. Pay things back quicker in general (because you’re paying more, obviously); but also
2. You make your fixed repayments more efficient (because less of the payment will be allocated to interest).

A graph of a 20 year mortgage at 9% on a R2 million property with a 10% deposit:

So here’s what happens when you pay an extra 10% per month:

Bottom line: you cut 4 years off your mortgage repayment period.

Here’s what happens when you escalate your mortgage repayments by 10% a year (that is: you attempt to keep your mortgage repayments as a fairly constant proportion of your salary – sort of):

Bottom line: you cut your mortgage period in half.

Here’s what happens if you do both (an extra 10% per month, and an annual escalation of 10%):

Bottom line: the extra 10% per month takes off an extra year, if you were already escalating at 10% per annum.

Here’s what happens when you pay on the 25th:

Permit me to zoom in:

You save a month. Unless I’m missing something dramatic.

The justification:

• I pay my first instalment a week early. So I save a week’s worth of interest, which goes toward capital.
• But then my second instalment is no longer a week early. It’s exactly a month later. In which case, I pay a full month’s interest on the full capital amount.
• The only saving is on my very first payment. Which, over 240 months of repayments, gives me a month off.
• Again, unless I’ve missed something.
• If someone has an alternative viewpoint, please point it out. I’d love to say “So listen, making your mortgage payment a week earlier means that you save a year and a half – for doing almost nothing!”
• But as it stands, I just don’t think that’s true.

So let’s just ignore that last, and assume that you pay an extra 10% per month, and you do an annual escalation of 10%. It means that you’ll have paid off your bond, in full, by year 9.

An Alternative

Because I love alternatives.

Instead of paying the money into your bond, let’s put the extras (the 10% per month and the 10% escalation) into a Satrix equivalent. Assuming a 15% annual return, here’s the growth path of your investment (alongside the capital portion outstanding of the standard mortgage):

Assuming that higher return, you could take the Satrix investment and use it to pay off the outstanding capital somewhere in the beginning of year 8.

But if I’m honest – I wouldn’t trade in a mortgage saving for a satrix return. The mortgage rate is almost a guaranteed return. In other words, once you’ve committed to buying a house, every rand of extra capital repaid “earns” a return equal to the mortgage interest rate. And you’ve already committed to the repayment process, so there’s less to be gained from going elsewhere.

So if you’ve already bought a house, pour money into the mortgage. But ignore the advice around the 25th. That’s what I’m saying.

For more in this series of home-ownership:

• Rent or Buy: The Problem with Home-Owning
• Rent or Buy: How To Be A Property Mogul
• Rent or Buy: Why You Should Just Buy A House

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

What’s happening with the investors:

So not a lot has changed since last week. And the indicators:

You’ll notice that the Repo Rate went up by 25 basis points? That came into effect last Friday.

I find that very few people actually understand rate hikes, or why they happen, or how on earth they’re meant to make a difference. So I thought that I might spend the rest of this post explaining it.

How The SARB thinks

So the South African Reserve Bank has a single mandate: “keep the inflation rate between 3% and 6%”. But it also has some other (minor) considerations, namely: “But, you know, we need to keep in mind that destroying the economy in the pursuit of that mandate would be a tad foolish.”

In all of this, the SARB has one tool with which to play: the repo rate.

Here’s what the SARB thinks/knows/believes will happen if they lower the repo rate:

1. Lowering the Repo rate means that it’s cheaper for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more expensive for them to keep money at the SARB).
2. So the banks, because they’re competitive, pass on some of that to cheapness to their customers.
3. People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got a little more spare money each month, because their monthly repayments have come down. So maybe they’ll spend more.
4. Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got a little more spare money each month, so they can perhaps afford to hire more people, or do more expansion, or whatever.
5. In addition, it just became a bit cheaper to borrow money – so perhaps people/businesses that hadn’t made some big purchase decisions beforehand might choose to make those purchases now.
6. Meaning that demand is stimulated – which would cause some inflation. But acceptable inflation when the economy is slowing down.

The problem:

1. Lower interest rates mean that foreign investors might start to earn lower returns on their investments (at least, that’s the theory).
2. And in particular, there will be lower forward rates in the foreign exchange market (which is driven by interest rates).
3. So foreign capital might start to leave South Africa in the search for higher returns.
4. Which would cause the Rand to depreciate.
5. Which would make imports quite expensive.
6. Which would hurt any industries that are reliant on imported goods.

And the opposite is true when the SARB raises the repo rate:

1. Raising the Repo rate means that it’s more expensive for the commercial banks to borrow money from the SARB (and, correspondingly, it’s more lucrative for them to keep money at the SARB).
2. So the banks, because they’re businesses, pass on the higher costs to their customers.
3. People with mortgages and hire-puchase agreements (on cars, etc) suddenly find that they’ve got less spare money each month, because their monthly repayments have gone up. So they’ll spend less.
4. Businesses with mortgages and hire-purchase agreements suddenly find that they’ve also got less spare money each month, so they might need to cut back and/or attempt to sell off assets in order to maintain their solvency..
5. In addition, it just became more expensive to borrow money – so perhaps people/businesses that were about to make some big purchase decisions might choose to delay those purchases.
6. So demand is suppressed.
7. Oh, and higher interest rates would cause the exchange rate to appreciate (normally).
8. Making South African exports quite expensive.
9. Which would hurt any industries that produce goods for export.

I would also point out on this whole exchange rate story that foreign capital is flighty. It almost only ever negatively impacts. And I say that because:

1. People doing long term investments into South Africa don’t make impulse decisions to get into and/or out of SA on the back of a 25 basis point rate movement. They’re concerned with things like “long-term sustainability” and “profit margins”. Of course exchange rates matter – but they’re a risk that can be managed.
2. The foreign capital that wreaks havoc on the exchange rate is speculator flows, which move into and out of bond and equity markets.
3. So the SARB needs to consider that whatever it does, the exchange rate will be affected opportunistically.

The Current Situation

The SARB has found itself awkwardly placed. On the one hand, inflation is up to 6.6% – which has them concerned because now they’re outside their mandate. But on the other hand, there is an economy that’s looking pretty stagnant with all the strikes and the depreciated Rand. Here’s ETMAnalytics‘ graph of the SARB’s GDP forecasts over the last year:

So the SARB might want to raise interest rates to stop the inflation, but raising interest rates also suppresses demand, which would prolong all this poor growth.

Either way, the SARB has elected to do something: they’ve raised the repo rate by 25 basis points. Which is really quite conservative.

And now we’ll wait to see what difference it makes.

Last week, I started talking about the various ways that Economists think about the world (The Economic Schools: Gettin’ Schooled). I have since found the summary table that Ha-Joon Chang uses:

Which I think is a bit brilliant. And from next week, I’ll start writing about each school individually.

But I thought I’d start this series of posts with a list of things I learned from Ha-Joon Chang. Mainly because there is much that we assume (yes – even the non-economic people think some of these things) that is either demonstrably false, or really not that clear cut.

Economics was not always called “economics” – it used to be called “Political Economy”.

Does that seem like a strange thing to bring up? Perhaps. But much of the movement in the economic world is to separate the State from the market through deregulation, free trade, Bitcoin, etc. As though, somehow, economics should be free of the politics of it all. Which is a bit ironic, seeing as economics is politics, and almost every economic viewpoint is based on one’s politics:

Economics is a political argument. It is not – and can never be – a science; there are no objective truths in economics that can be established independently of political, and frequently moral, judgements. Therefore, when faced with an economic argument, you must ask the age-old question “Cui bono?” (Who benefits?). 

Economics is too important to be left to the experts

Economics has been uniquely successful in making the general public reluctant to engage with its territory. People express strong opinions on all sorts of things despite not having the appropriate expertise: climate change, gay marriage, the Iraq war, nuclear power stations. But when it comes to economic issues, many people are not even interested, not to speak of not having a strong opinion about them. When was the last time you had a debate on the future of the Euro, inequality in China or the future of the American manufacturing industry? These issues can have a huge impact on your life, wherever you live, by affecting, positively or negatively, your job prospects, your wage and eventually your pension, but you probably haven’t thought about them seriously.

There is no single economic theory that can explain Singapore’s economy.

The Economist likes to credit Singapore’s success with its free trade policies and low tax regime. It’s hailed as the most open and least corrupt and most pro-business economy in the world – almost as though there is no government interference with things. But nearly all of Singapore’s land is owned by the Singapore government, 85% of the housing is supplied by the government’s housing corporation, and State-Owned Enterprises produce 22% of Singapore’s gross national product (the world average is 9%). Singapore is both a socialist and a capitalist success story…

Britain and the US invented protectionism, not Free Trade

These countries were super-protectionist (way more than by modern standards) in the 18th and 19th centuries. Britain protected her industries against the “Low Countries” (Belgium and the Netherlands). And $10-dollar-note-man Alexander Hamilton developed the “Infant Industry Argument” (that some industries need to be protected in their early growth stages, until they ‘grow up’).

Free Trade was first colonial

Britain traded freely with her colonies… And Britain also imposed free trade on some of her partners by, well, winning wars. Example: in 1842, the Nanking Treaty with China after the opium wars.

The Welfare State was first proposed by conservative right-wingers

State welfare was not a “democrat-led” proposal presented by bleeding-heart liberals. The first proponent was “arch-conservative Otto von Bismarck”, who hated socialism, but felt that without a minimum safety net for workers, they might be seduced by more hardcore socialism.

The Golden Age of Capitalism took place under high regulation and high taxes

Well it’s true – everyone talks about the 1950s, 60s and 70s as being a high-point. Well, that was in a time before Ronald Reagan and Margaret Thatcher started slashing taxes and deregulating things.

The Internet was invented by the US Government

The private sector is not the only source of innovation.

“The ‘lazy’ Greeks are the hardest-working people in the rich world, after the South Koreans.”

Greeks work between 1.4 and 1.5 times as many hours per week as the Germans and the Dutch. Italians also work longer hours than the Germans. It’s not about laziness – it’s an issue with productivity*.
*And, possibly, Mediterranean statistics. But let’s not be pessimistic.

I owe some of the above to this zerohedge article: What Piketty Forgot. I also recommend this one: The Shortest Economics Textbook Ever (the article is longer than the book).

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.