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.