Settling Your Loan
People often ask why I take out a 30-year bond when buying property, and my answer is always the same … Because there is no 40-year bond available I am then usually informed how much more interest I’ ll have to pay if I take a 30-year bond, but they forget that I am not paying the interest – my tenants are!
So, my personal benchmark and mantra for property investment is to buy as many properties as I can and pay them off as slowly as I possibly can as long as the return of the property( the capital appreciation and the net rental yield) is higher than the interest on the loan.
We must always consider opportunity cost, which is the loss of other alternatives when one alternative is chosen. For example, there is an opportunity cost to taking a 20-year bond rather than a 30- year bond, and that is the loss of other property investments you could have made with the additional funds you are paying into the bond.
You may argue that the monthly payment difference between a 20-year bond and a 30-year bond could be less than R1,000. It doesn’ t sound like a lot, but that same amount could be sufficient to cover the shortfall of another investment property that can give you a much greater return than the savings on paying off your bond quicker.
If you’ ve read some of my other articles, you would know that everything in property investment is about cash flow. The less of your money you use – whether for deposits or shortfalls – the more properties you can own. That is also why you should always try to get 100 % financing from the banks.
Keep in mind that if you take a 30- year bond, you’ ll have 10 extra years to refinance the property. So, when you are following a refinancing strategy to build your property portfolio, you want your bonds to be as long as possible. Let’ s consider another example:
If you have R2,000 to invest per month, and your shortfall is R2,000, you can only own one property. If, however, your shortfall is R500, you can own four properties. And if you have NO SHORTFALL, you can own an infinite number of properties!
I don’ t know about you, but I’ d rather have more properties that I’ m paying off slower than fewer properties being paid off faster! After all, more is more in property investment!
Note: When you take this approach, it is imperative to have a strong reserve fund in accessible cash as changes in interest rates will affect you significantly more because you have more debt that is being paid off slower. For me, a strong reserve fund means at least 10 % of the value of my properties.
I would also not follow this strategy for my primary residence. The reason I’ d rather have my primary residence in a separate trust and paid off is that this property’ s purpose is not primarily for investment. For an investment property, however, I am more than happy never to pay off my bonds!
SOURCE Prosperity Enterprises
SA Real Estate Investor Magazine APRIL 2021 21