Using mortgages as a long-term savings tool

The price of an average house in South Africa, as measured by the ABSA House Price Index, is set to break through the one million rand mark in coming months.

In April, the average price of a 'medium' house already stood at R911, 800. There is little doubt that first-time home buyers will struggle to get there feet on the property ladder in coming months.

ABSA notes that "the Absa House Price Index is based on the total purchase price of houses in the 80m to 400m size category, valued at R2,7 million or less in 2006 (including improvements), in respect of which loan applications were approved by Absa." While it includes quite a range of property sizes and prices, the index still provides a good indication of what is happening in the market as a whole.

Of real concern is that growth in house prices in entry level housing remains strong. A quick look at new developments in the Gauteng region reveals that two bedroom stack simplexes typically sell off plan for between R500, 000 and R695, 000. And these properties are seldom more than 70 square metres!

A question of affordability

It now seems inevitable that the Reserve Bank governor, Tito Mboweni, will announce another interest rate hike on 6 June 2007. The prime lending rate is likely to move from 12.5% to 13.0% and exact a toll on every bonded home owner.

Comparing the situation at the end of March 2007 to that which existed a year ago, there is no question that houses are becoming less affordable. In March 2006, ABSA's House Price Index recorded the average price of a 'medium' property as R772, 614. The mortgage repayment on this property required a gross monthly salary of R25, 712. Today's average requires a monthly salary of closer to R35, 000 (before the coming interest rate hike).

In a low inflation environment, the required increase in gross monthly salary to afford the same house is more than 30% in one year. So much for the Reserve Bank's 3% to 6% target for CPI.

Always consider tax implications of investments

Houses remain a big ticket item, and most South Africans will probably only make a house purchase once in their lifetimes. Inflationary pressure in the house price market underlines how important it is to maintain inflation beating returns when investing money.

South Africans have traditionally considered four asset classes when investing. These are equities (shares), property, bonds and cash. But there is another saving activity which rewards investors with solid returns. It is as simple as using spare cash to reduce the outstanding balance on your mortgage bond.

On 1 June 2007, the unimplemented legislation in the National Credit Bill comes into effect. It demands that financial institutions exercise due care in extending credit to the local consumer. These consumers should be aware that debt, regardless of its type, comes at a high price. One of the first steps to financial independence is to eliminate expensive short-term death. And once this is done, one of the most effective after-tax savings strategies is to reduce long-term debt by paying additional money into your home loan.

Home loan repayments a top saving activity

This advice is confirmed by a recent survey completed by Credit Suisse. Their 2007 Asset Performance Survey revealed that individual investors could secure significant after tax returns by making additional payments to their home loan accounts. The reason this strategy is so successful is that the interest savings on the home loan payments are not viewed by the Receiver as income. There is thus no negative tax implication with this form of saving.

The after tax return on additional cash ploughed into mortgages ranked second only to equities over the last 20 and 15 years. However, with global interest rates on the decline, this strategy fell to fourth place over shorter investment periods.

With interest rates on the rise, and the average price of a 'medium' home heading toward the magical million rand mark, it makes sense for home owners to at least consider this savings strategy.

Editor's thoughts:
Much has been written about the low savings rate in South Africa. Making additional payments to mortgage accounts will probably not affect this rate, but they will help to reduce the total amount of credit extended to the local market. Do you believe that making additional payments to your home loan account represents a sensible savings strategy? Send you comments to [email protected]