Debt or deposit?

Sep 25 2012 14:05

A Fin24 reader writes:

I have put in an offer for a house for R1.45m. I applied for a bond, and have R230 000 to spend on a deposit. I need advice on how to spend the R230 000.

I still owe R85 000 on a vehicle, with monthly repayments of R3 600 at 13%. I also owe R100 000 on a property with a bond of R230 000, with R1 500 per month repayments at prime.

To me it makes sense to knock off the vehicle, which is at the highest interest rate, and free up more disposable income, making the R1.4m bond more affordable.

The advice I'm receiving from the bank, however, is to put down the cash as a deposit on the house. I'm prepared to do whatever makes the bond acceptance more likely, but to me the bank's advice and common sense don't seem to be matching.

David Te Brake, a financial adviser at Pioneer Financial Planning, responds:

Your applied logic is excellent and you seem to be on the right track.

It's more common these days to see people take a higher interest rate in the form of a personal loan, simply to consolidate debt that has got out of hand. You, however, seem to have your ducks in a row.

Paying off shorter-term debt with a higher interest rate is always advisable since it allows you to save on the incremental differences between the interest rates of the different liabilities.

You mentioned a bond that you have on an additional property. Should this be rental property, it's always important remember the tax advantages of such investments. 

The interest paid on such property can be deducted against the income (rental) earned on the property. This will reduce the tax payable on rental received from the investment. 

Remember, this only applies to the first time the property is bonded. If the property is re-bonded or the bond is "accessed" and the funds used to finance something unrelated to the property, the interest on this refinanced capital will now not be deductible.

So in getting to the point of why the bank suggests you put down a deposit on the property: well, the answer is this simple - they want your money!

Credit legislation has made the raising of finance quite difficult for an investor. The bond originator or financer knows that your only option in getting this bond may come from the saving grace of a chunky deposit.

Remember the three Ts

Obtaining a bond these days is not as easy as it was even five years ago, and 100% bonds seem almost impossible to get your hands on.

Bottom line: if you want to buy the house, you will have to put down a deposit.

But you'll need to factor the opportunity cost of this decision into the purchase price of the house, particularly if this property will be your primary residence, which I like to refer to as "black hole lifestyle enhancements".

The residential property market is not giving the same capital (price) returns as it has over the past 15-20 years. Know the area you're buying in.

Remember the three Ts of your area when buying a lifestyle property: check out the trends, the traffic and the tsotsis.

Sometimes things aren't as clearcut as they should be, unfortunately. The reality is you may need to buy a cheaper home. Your logic and your gut feel may be at war.

You've clearly applied your logic to this, so then it may not be the worst thing in the world to trust that gut on this one.

- Fin24

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property  |  investing  |  debt



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