Per­fect time to cut your debt

Bond­hold­ers can reap the ben­e­fits of lower in­ter­est rates, writes Clin­ton Mar­tle

Business Day - Home Front - - HOMEFRONT - Clin­ton Mar­tle is First Na­tional Bank home loans re­gional sales man­ager — Western Cape.

THE Western Cape has the high­est level of in­debt­ed­ness — or debt-to-dis­pos­able in­come ra­tio — of SA’s prov­inces to the tune of 101%, ac­cord­ing to the Bureau of Mar­ket Re­search (BMR) statis­tics.

FNB’S prop­erty mar­ket an­a­lyt­ics unit has ac­cu­mu­lated a wealth of statis­tics, in­clud­ing these pro­vin­cial in­debt­ed­ness es­ti­mates.

Gaut­eng has a ra­tio of 88%, well lower in sec­ond place.

Of SA’s nine prov­inces the Western Cape can be con­sid­ered a rel­a­tively high-in­come prov­ince with the sec­ond-high­est per capita in­come be­hind Gaut­eng.

Higher-in­come house­holds can gen­er­ally take on and ser­vice more debt rel­a­tive to dis­pos­able in­come than lower-in­come groups, so it should be ex­pected that the Western Cape’s debt ra­tio would be at the higher end of the spec­trum. How­ever, the fact that the BMR es­ti­mates its ra­tio to be sig­nif­i­cantly higher than Gaut­eng, the high­est in­come prov­ince, is pos­si­bly con­cern­ing.

I’m cer­tainly not an ex­pert on house­hold-sec­tor in­come pat­terns, but a large part of house­hold debt is prop­erty-re­lated.

Con­sumer goods prices don’t vary much be­tween prov­inces, while prop­erty val­ues do, and the Western Cape’s land scarcity makes it the most ex­pen­sive prov­ince for prop­erty.

In or­der to com­bat high land prices the Western Cape re­duced the av­er­age stand size and also re­duced the av­er­age build­ing size, so com­pared with Gaut­eng and KZN it has a sig­nif­i­cantly smaller av­er­age stand size.

The land cost is­sue has even spilled over to park­ing, and a far greater per­cent­age of sec­tional ti­tle units in the Western Cape do not have al­lo­cated park­ing (75%), com­pared with KZN (38%) and Gaut­eng (17%), sug­gest­ing a gen­eral un­der-pro­vi­sion of sec­tional ti­tle park­ing in the re­gion.

The park­ing is­sue is driv­ing up the com­mod­ity price to un­re­al­is­tic lev­els and shows that prop­er­tyre­lated mea­sures to ad­dress af­ford­abil­ity/cost-of-liv­ing is­sues could ben­e­fit from cut­ting your coat ac­cord­ing to your cloth.

How­ever, in­creas­ing debt to main­tain a life­style not only causes trou­ble for in­di­vid­u­als, but also bears down heav­ily on re­gions and ul­ti­mately the coun­try as a whole, as seen in the US and UK.

While the ef­fect of the Western Cape’s high level of es­ti­mated debt–to-dis­pos­able in­come ra­tio is dif­fi­cult to de­ter­mine, I be­lieve it must have some ef­fect. What we do know is that dur­ing the last in­ter­est-rate hik­ing cy­cle, which wasn’t ex­treme by our his­toric stan­dards, SA’s level of in­debt­ed­ness caused a high de­gree of pain in terms of bad debts. It causes the Western Cape to be at the high­end of the in­debt­ed­ness spec­trum, in­creas­ing its vul­ner­a­bil­ity to in­evitable in­ter­est-rate hikes and eco­nomic down­turns.

If you are not on the hous­ing lad­der yet, now may be a good op­por­tu­nity to get on, but be care­ful to buy within your means, bear­ing in mind ris­ing costs that in­clude in­ter­est rates, elec­tric­ity and pos­si­bly other util­ity tar­iff hikes. How­ever, given the Western Cape’s state of in­debt­ed­ness, the cur­rent low in­ter­est rates presents an op­por­tu­nity to pay down debt more ag­gres­sively and build a health­ier bal­ance sheet.

While viewed as in­signif­i­cant by some, half a per­cent­age point re­duc­tion in in­ter­est can have a very sig­nif­i­cant im­pact, as il­lus­trated in the graph, show­ing the sav­ing on a R500 000 mort­gage loan at present would be R160.

How­ever, as­sum­ing the hy­po­thet­i­cal sit­u­a­tion of a 10% in­ter­est rate for the en­tire du­ra­tion of a R500 000 20-year mort­gage loan, monthly re­pay­ments would be R4 825, im­ply­ing the bond be­ing re­paid in 240 months or 20 years. A re­duced in­ter­est rate of 9,5% on the R500 000 loan, when the bond­holder fixes his re­pay­ment at R4 825 thereby re­sist­ing the temp­ta­tion to re­duce his monthly re­pay­ment, shows that the same R500 000 bond will now be fully re­paid in 218 months, a year and 10 months ear­lier than the same re­pay­ment at 10% in­ter­est. In ad­di­tion, the bond­holder would also have paid R68 045 less in­ter­est had the bond been paid over 20 years.

Small mea­sures can re­sult in sig­nif­i­cant change in an in­di­vid­ual’s fi­nan­cial fu­ture, and with in­debt­ed­ness so high in the Western Cape the pe­riod of low in­ter­est rates is a per­fect op­por­tu­nity to take ad­van­tage of the long-term ben­e­fits. Why are we en­cour­ag­ing clients to pay down their debt on which the bank earns in­ter­est? For the sim­ple rea­son that if our clients are fi­nan­cially healthy, then so are we.

Es­ti­mated house­hold debt-to-dis­pos­able in­come ra­tio by prov­ince for 2009. Pic­ture: Bureau of Mar­ket Re­search.

Clin­ton Mar­tle ... in­creas­ing debt to main­tain a life­style causes trou­ble for in­di­vid­u­als.

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