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Monday, 22 October 2012

Invest or increased mortgage payment? Which would have the greater impact on your balance sheet?



Improving your financial health requires you to pay attention to paying off your liabilities (debt) and building up your assets (investment). Paying off short-term debt could be the best investment you ever make, but paying off longer-term debt at the expense of long-term savings could also be detrimental to your financial plan.
Use short-term savings to pay off short-term debt (See table):
By using the money market savings to pay off the debt, you would effectively have a 20% return on your money: you would have saved 25% (paid to the bank) but lost out on the 5% interest on your savings.
20% is the best return you could hope to have on a short-term investment. You can then use the money you would have paid on your monthly credit card payments to top up your money market account. The most important rule however is to not take on further debt!
OPTION 1  Keep money market savings and credit card debt separate
SAVINGSDEBTRESULT AT END OF YEAR
R20 000: Money Market AccountR15 000: Credit CardNet positive financial position of R2250
5% (R1000) a year interest earned (R21000 year-end balance)25% (R3750) a year interest owed (R18 750 year-end balance)
OPTION 2 Use money market savings to pay off credit card debt
SAVINGSDEBTRESULT AT END OF YEAR
R5 000: R20k less R15k to pay credit cardR0: R15k paid off with money market accountNet positive financial position of R5250
5% (R250) a year interest earned25% (R0) a year interest owed
Increase your monthly short-term debt payments
By using the additional R600 to pay off the loan within just one year, you would have saved R2 000 in interest. The following year you would be able to use both your R600 savings and R800 from the loan repayment to start a savings plan of R1 400. Again it is important you don’t use this additional money to take on a further loan. Your aim is to improve your balance sheet.
OPTION 1: Save additional income and make minimum monthly payment on debt
SAVINGSDEBT REPAYMENTRESULT AT END OF SECOND YEAR
R600 a month: Bank AccountR800 a month: to repay R15 000 Personal Loan at 25% over 24 monthsDebt paid and R14 400 in savings
OPTION 2: Use additional income to pay off debt in one year and then increase monthly savings
SAVINGSDEBT REPAYMENTRESULT AT END OF SECOND YEAR
First year: R0 a month: Bank Account First year: R1400 a month: R600 savings plus R800 debt repaymentDebt paid and R16 800 in savings
Second year: R1400 a monthSecond year: R0
Cut four years off your bond
By increasing your bond repayments by 10%, you will pay off your home loan four years earlier. On a R1 million mortgage you would save yourself around R195 604 in interest. And when interest rates go up, you will already be paying the higher new minimum repayment amount so you won’t have to change your budget to accommodate the increase.
Don’t put all your money into your home loan
Your house is not a retirement asset but a life asset that needs to be paid off over time. If you save all your money into your home loan you may be debt free but you will have no retirement savings to meet your daily expenses.
OPTION 1: Pay extra into mortgage with no savings
MORTGAGEBALANCE SHEET AFTER 16 YEARS
R1000 additional payment into your mortgageMortgage fully paid, no other assets
OPTION 2: Invest money for long-term growth
SAVINGSBALANCE SHEET AFTER 16 YEARS
R1000 a month investment that delivers inflation plus 5%R525 000: investment value
R380 000: still to pay on mortgage
R145 000: net positive
A long-term investment may have a greater impact on your balance sheet so find a balance between paying off your home and investing in assets other than your property. Your choice will depend on interest rates, investment markets and tax.

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