Managing your mortgage
Buying a home of your very own for the first time is a very big event. This step in your life can be both exciting and scary – especially if you are doing it on your own. With lots of questions and unfamiliar procedures that you have to comply with, it is no wonder most people get caught up in the red tape.
First it is the excitement and later the dread of finding the perfect home. It is great when you can finally tick all the boxes – the property you have found has everything you wished for and more. Then comes the nail-biter – working out if you can afford the house, making the offer and waiting for painful hours or even days to find out if they will accept your offer. Once the offer has been accepted, you will sign lots of documents and get lost in the paperwork. One of these documents will be your Mortgage bond.
Finding your dream home is the fun part, but then you have to sit back, work out your finances and apply for a loan. And then of course you have to pay it back!
What is a mortgage loan?
The word "mortgage" means to "pledge" or "promise" something. The correct name for a loan over a property is a Mortgage Loan but in South Africa, we call it a ‘Bond’ from the document that you sign. The Mortgage Bond is the document that you sign that contains this promise to repay the money to the lender. The terms "mortgage" and "bond" therefore usually mean the same, and are used interchangeably.
In other words when you take out a mortgage loan you "promise" your property as security to the lender in case you cannot pay back the loan. When you buy a property and get a loan with a mortgage lender, the house is yours. It is registered in your name and you are fully responsible for it.
The costs involved in buying a home
As well as the purchase price, there are a number of other big expenses when you buy a home. Transfer Duty and the transfer costs may be your biggest expense in purchasing your property. Transfer Duty is paid to South African Revenue Service every time a property changes hands. No transfer duty is payable in respect of a new purchase from a Developer. The purchase price includes VAT which is payable by the Developer. For all other purchases, duty is calculated according to the purchase price of the house. If the home is bought for R600 000 or less, no transfer duty is payable. This value is reviewed periodically by the Minister of Finance.
Registration of the mortgage bond:
If you take out a loan to buy your home, there is also the cost of registering the Mortgage Bond. This is the document confirming the mortgage, which is registered at the Deeds Office.
There are also other smaller costs that you may need to allow for, e.g. the lender's administration fee. Be sure to ask your lender for a breakdown of all the costs you will be expected to pay.
Let us have another example:
On a R950 000 home, the transfer costs (including transfer duty, as well as the various attorney costs and VAT) could amount to about R28 000, and the bond registration process carries separate costs of about R16 000.
How much will I be able to borrow?
Affordability: this is the big question every homeowner-to-be wants answered. As a guideline, your instalment should not be more than 25% - 30% of your regular family income, before tax and deductions. If you have your own business or earn regular overtime or sales commission, the various lenders will each have their own formula for calculating what they consider as regular income. You will need to provide some proof of earnings.
For a family where both partners work, the calculation might be something like this:
- Salary 1 (before deductions) – R15 700 per month
- Annual bonus (divided by 12) – R2 000 per month
- Salary 2 (before deductions) – R12 200 per month
- Housing subsidy – R1 500 per month
- Total regular family income – R31 400 per month
At a 30% instalment to income, this family should be able to afford a repayment of R9 400 per month, which would mean their maximum loan would be R800 000, based on an interest rate of 13% p.a.
Note: It is important to find a responsible lender, who will look specifically at the unique affordability issues for each borrower.
Responsible credit lenders will take a broader view of the affordability of each borrower into consideration. They will look at the Household Income compared to the Household Expenditure of the applicant(s) - including all current debt repayment commitments.
If you would like to know with more certainty what you will be able to borrow, you can apply to the lender for provisional credit approval before you buy - this is known as a pre-approval. Then you will have a much better idea of what price property you can afford. However, the bond will not be pre-approved – you will only be informed of how much you can borrow, if and when you put in an offer to purchase.
What are the different types of mortgages repayments available?
Repayment mortgage - In a typical repayment mortgage the lender calculates your monthly repayments by spreading out (amortising) your capital loan and your interest, so that by the time your mortgage term finishes (20 years, for example) you will have paid off everything. Remember, each time you pay off a bit of the principal sum your interest loan is also reduced.
In the beginning, you'll be paying off mostly interest, so if you sell up in the early years you'll find you've hardly paid off any capital at all. But after a few years, you'll be whittling away at bigger and bigger chunks of the capital. Many lenders now offer flexible repayment mortgages too, so that you can pay more than the agreed monthly amount when you can have more money available, and even take 'payment holidays' depending on the circumstances.
A repayment mortgage is the surest and safest way to pay off your loan. It is the route to take if you absolutely, categorically, do not want to risk the roof over your head in any way whatsoever. You borrow the money and you pay it back in instalments - it is as easy as that.
Interest only mortgage - With this type of mortgage your monthly payments are only used to pay off the interest on the loan. This means your monthly payments are less but you are never reducing the principal sum and hence you either sell the property at the end of the term, and pay off the principal sum or you may have saved enough money another way to enable you to pay off your mortgage without selling the house. This is a high-risk strategy and you may be forced into a corner. It also makes your loan extremely expensive because you would have paid maximum interest.
Some borrowers take out interest-only mortgages and use the savings they make (from not making any capital repayments) to pay into an investment fund, with the idea being that the investment fund will rise more in value than the interest rate on your mortgage. If that happens you would have enough money to pay off the principal sum at the end of the term of the mortgage.
Individuals who expect their earnings to increase significantly, such as young professionals, or those starting their own businesses, may prefer an interest-only mortgage at the start to reduce their monthly spending, but they then usually convert to a repayment mortgage once their income increases.
Note: With this option, because you are only paying the interest on your mortgage, you will be more affected by movements in interest rates by the Reserve Bank. If you have a tight budget, this is another thing to bear in mind.
Mortgage interest rates - The interest rate of the loan you take out in order to buy your house is crucial. It will determine how much you can afford to borrow and therefore how much you can afford to spend buying your home.
Your mortgage consultant should be able to advise you on the interest rate you are likely to pay. Your interest rate will depend on a number of factors including (but not limited to) the following:
- The Loan To Value (LTV), which is the amount of money you are borrowing compared to the price of the house you are buying or own
- Your repayment compared to your income (the cost of your monthly mortgage repayment compared to the amount of your disposal income used to make those payments)
- The size of your bond
- Your credit profile
Note: The interest rate should not be the only factor that you look at when deciding which mortgage to choose. South African lenders are becoming far more innovative in offering different types of mortgages. Speak to your lender agency about this.
How is the interest charged on a mortgage?
In South Africa interest is generally charged daily on your mortgage, so payment immediately reduces the amount that you owe. Some lenders will allow you to pay your mortgage repayments twice a month; this will dramatically reduce the amount of interest you will pay over the lifetime of your mortgage.
Help for first-time buyers
It is harder to get on the property ladder today than it has ever been. But there are many ways first-time buyers can get a leg up.
Of course, if this is your first house purchase this is all pretty daunting stuff. It can also be extremely expensive as you have to find an awful lot of money. Luckily, you will find a bit of help as lenders usually give preferential Loan to Value mortgages (108%) to First Time Buyers.
The size of mortgage that you are eligible for depends on your financial situation. You need to plan this in advance to make sure your finances are in the best possible condition for when you apply for a mortgage. Start these preparations at least three months before you apply for a mortgage. You will need to try and reduce your monthly expenses to a minimum to prove to the lender that you can manage your expenses, and try and save as much as possible for the additional costs of purchasing your home. Make sure that any old debts are paid off and do a credit check to make sure there are no ‘gremlins’ lurking that may surprise you.
Once you have done all of that, fill in an application form at a loaning agency and a consultant will contact you. Ask them to calculate how much you can afford before you go out house hunting.
But if you are having trouble finding the cash to consider buying in the first place, here are some ideas that may be useful:
Get help from your parents
This is not an option for some people, but – according to a recent report – many First Time Buyers (FTBs) are getting help from their parents, usually in the form of a deposit. If your parents can afford to give or lend you a lump sum to help you bridge the gap between the price of a home and a mortgage you can support, then do not turn down such an offer.
Alternatively, they may be happy to buy the house with you on the understanding that you will buy them out of their share later when you can afford it, or that they get a share of any growth in value when you sell up. You could ask them to act as surety for the mortgage, either jointly or on their own, but that would mean a big commitment on their part - if you fail to meet your mortgage payments, they'll be lumbered with the payments!
Buy with a friend
You might not be able to afford to buy by yourself, but you could possibly manage it if you went half-half or even split it three ways with a friend or two in the same position.
This method is becoming increasingly common - after all, if you have been renting a flat with your best mate from university for the last couple of years, why not continue sharing, but in your own home?
At first this may sound very exciting, but there are some major considerations - such as, what happens when one person wants to sell, but the other does not?
Make sure you agree on a legal basis the ground-rules before signing on the dotted line. Each of you should have your own solicitor to prepare legal agreements to ensure you are fully protected from your co-owner should the friendship go pear-shaped.
You should usually also make sure you buy your property in a company name; although it is more expensive to set up, it does mean that you can ‘sell your share’ when you want to move on. It will also mean that your share will become part of your estate if you should die, rather than passing automatically to your co-owner.
Get a longer mortgage
The usual length of a first-time mortgage is 20 years which sounds like a scarily long period of time. But it's not unusual for people to upgrade to their next home a few years later and take out a new mortgage for exactly the same length of time.
So the idea of looking for a 30-year mortgage in the first place, or maybe even longer, need not be dismissed out of hand. It also means that you can afford a bigger mortgage as your repayments will be lower, due to the longer time period
The crucial thing to look for is that, even if there is an initial lock-in period, you subsequently have the facility to overpay when you can afford to. The longer the mortgage, the more you will pay overall, so your ultimate aim should be to overpay when feasible, thus reducing the length of the mortgage term.
Tips for paying back your mortgage
Make sure your monthly home loan instalments, rates and taxes are kept up to date at all times.
If, at any time during your loan term, you find yourself in financial difficulty, it won’t help to bury your head in the sand like an ostrich – seek help. Speak to your mortgage lender and municipality.
A responsible lender will do everything they can to help you get through difficult times. Payment arrangements could also be made with the municipality.
Twenty years is a very long time and 30 years is even longer. Many homeowners will spend nearly their whole adult lives repaying their home loan. Financial institutions will suggest products and methods to help you pay off this mortgage quicker. However, most of these have proven to be less effective than simply paying more.
Comparison between two pay-more strategies
Here are two different pay-more strategies that can be used to reduce your home loan term, followed by a comparison to see which of the two strategies would be the best to achieve an optimum term-reduction of five years, ten years and fifteen years respectively.
For the purposes of this example, we used a 30 year, R 1 million mortgage, at an interest rate of 14%. This translates into a principal of R 1 000 000 and R 3 265 538.30 in interest if the loan is repaid over the full 30-year term.
Strategy 1 – Pay More Every Month: The first strategy is to pay an extra amount against your home loan every month.
The Less 5 Year Target: To reduce your term to 25 years, you will need to pay R199 extra every month. A term reduction of 5 years results in a saving of R 673 565.20 in interest.
The Less 10 Year Target: To reduce your term to 20 years, your will need to pay an additional R 600 per month. A term reduction of 10 years results in a saving of R1 295 365 in interest.
The Less 15 Year Target: To reduce your term to 15 years, you will need to pay R5 000.00 extra on your home loan every month. A term reduction of 15 years results in a saving of R2 412 329 in interest.
Strategy 2 – Pay your Home Loan an Annual Birthday Bonus: The second strategy is to make an additional lump sum payment as an annual birthday bonus against your home loan, starting when you pay your very first instalment.
The Less 5 Year Target: If you pay R2 200 as a lump sum into your home loan account every year, you will repay your home loan within 25 years and save R673 009 in interest.
The Less 10 Year Target: If you pay R6 750 as a lump sum into your home loan account every year, you will repay your home loan within 20 years and save R1 303 252 in interest.
The Less 15 Year Target: If you pay R16 800 as a lump sum into your home loan account every year, you will repay your home loan within 15 years and save R1 894 396 in interest.
So, Which Is The Better Of The Two Strategies?
The Less 5 Year Target:
- Strategy 1 costs R188.04 more per year than Strategy 2.
- Strategy 1 delivers R556 greater savings on interest than Strategy 2.
The low down: Considering that Strategy 1’s R566 greater saving in interest rate will cost you R4 701 over the 25 years, the outright winner here is Strategy 2.
The Less 10 Year Target:
- Strategy 1 costs R450 more per year than Strategy 2.
- Strategy 1 delivers R7 887 less savings on interest than Strategy 2.
The low down: Considering that Strategy 1’s saving in interest rate is R7 887 lower and that it will cost you R9 000 more than Strategy 2, the outright winner here is Strategy 2.
The Less 15 Year Target:
- Strategy 1 costs R43 200 more per year than Strategy 2.
- Strategy 1 delivers R517 933 greater savings on interest than Strategy 2.
The low-down: Considering that Strategy 1’s R517 933 greater saving in interest rate will cost you R648 000 more over the 15 years than Strategy 2, the outright winner here is Strategy 2.
As a strategy, lump sum payments could be more effective than paying bits and pieces every month. If you do have some extra money at the end of any given month, by all means, add this to your mortgage too. It is bound to offer a better return than that of your savings- or current account.
Should you want to know how making lump sum payments will affect the interest and the term of your particular home loan, contact your mortgage originator for assistance.