Below is a piece from a recent Treoc newsletter
“People who have not built up reserves should start doing so quickly, or they should reduce their exposure. I have thought a lot about the consequences and dangers of fluctuating interest rates. Everyone knows that what comes down will go up again and what goes up will come down. Everyone knows this, but not everyone knows how to manage these fluctuations. So it would be best to eliminate the fluctuations as far as possible. If we can do this, then we will have automatically eliminated the consequences too. How do we get this right? With fixed payments!
The average interest rate since 1994 has been approximately 16% per year. If we deduct from that an average discount of 1% that gives us an effective rate of approximately 15% over that period. At times we would have paid more and at times less. But if we had paid 15% every year, the fluctuating rates would have had no effect on us. Do you agree? If this is true, then let’s do it this way.
Do a bond repayment calculation at a rate of 15% and request your bank to never take off less than that monthly amount per debit order in future. If we had already started doing this in 1994, today we would have had a nice fat reserve to absorb the rising interest rates, because all the extra money we’d paid in over the years would have been available on access bonds for the times when the effective payments were greater than 15%.
How would this practice affect our refinancing programme? Very positively, I think. You’ll always be a little ahead on your bond payments, which should make the approval of refinancing bonds easier. Just don’t forget to leave the reserve behind in the bond when you withdraw the refinancing cash.
To put it another way, it works like this: If your registered bond is equal to the value of the property and your outstanding bond is 70% of the registered bond, you have a reserve of 30%. That means that on a R500,000 property we have a reserve of R150,000, which is more than enough to absorb fluctuations in the rates.
So to sum up: We do a fixed payment on our bond that is more than the current interest rate and in this way create a credit on our bond account, which brings our gearing ratio down and pushes our reserve up.
Exclusive Realty Comments
This really is common sense and if you are only just meeting your bond repayments, the bank should never have lent you the money in the first place.
So once you get a bond, make sure you add an extra 10%-30% to the repayment amount on a fixed basis. Then when the interest rates go up, you don’t even notice it and it won’t affect your lifestyle.
What can make this tricky is if you have one bond that is getting a far worse rate than another (e.g. one bond at prime -2 and another at prime -1). Then it would make more sense to put all your excess money into the bond of prime -1 first. Just make sure you have a reserve plan when the rates go up!