Highlights in this issue:

*** Shattered: 6 bond repayment myths…
*** Use the power of leverage to your advantage…
*** Let “cheap” money work for you…

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From the pen of Karin Iten…

Dear Investment Academy Reader,

Financial experts will tell you to pay off your bond as fast as possible. But they’re not always right.

You see, sometimes it doesn’t pay to pay off your bond faster. And today – I’ve asked MoneyWeek editor, Gareth Stokes, to show you why…

Picture this…

Let’s take a look at some numbers before we jump to any conclusions. Let’s consider a mid-segment property worth R820,500. You get a 90% bond (R750,000), repayable over 20-years at 1.5% below the current prime interest rate – or 10.5%.

If you decide to repay the loan in line with the bank’s 20-year repayment schedule you’ll part with a total of R1,797,081 at R7,487.84 per month. Your total repayment includes R1,047,081 in bank interest.

Most property owners baulk at this number and vow to show their bank the middle finger by paying back the loan as soon as possible. If you manage to scrape together an extra R500 per month you can knock R120,000 from your interest bill and repay the loan 16 months early.

But is this really a good idea?

Before you increase your monthly repayments by R500 – consider this…

I have six arguments to support a more relaxed approach to repaying your bond…

#1: You get more financial leverage
It’s a good reason to use bank finance to buy a residential property because of “gearing” or “leverage”. In the above example, you secure the use of an asset worth R820,500 with zero money down The capital appreciation in the property accrues to as profit, magnifying your overall return by multiples when compared to similar growth on a “paid for” asset.

Why would you reduce the leverage this financial instrument affords you by settling your bond early? And property prices will always increase over a long period of time. Yes, we’ve seen property prices fall over the last year or two, but by 2011 we should see strong growth again.

#2: Your money is worth more today than it will be tomorrow
This is one the best reasons to delay bond repayment. Economists call it the “time value” of money. But to put it simply: “A bird in the hand is worth two in the bush.” The interest savings you achieve by upping your repayment will occur at some future date. And while saving R120,000 sounds impressive in today’s money, remember that by the time you “earn” this money 20-years in the future, its value will have been eroded by inflation.

#3: Bond repayments become easier with time
In a high-inflation setting your bond repayment becomes easier to make each year. For example, think of your bond repayment as a percentage of your net disposable income. If your net income is R15,000 per month and your bond repayment is R7,487.84 at the start of the loan, then your repayment gobbles up 50.08% of your salary. After 10-years of inflation your net salary should have risen to around R27,500 per month – and your bond repayment will only account for 28%.

#4: House prices increase over time
Many property owners think they unlock more value in their primary asset by paying the property off sooner. In reality, house prices go up regardless of your bond repayment activity. Extra bond repayments mean a slightly larger cash reward when you sell, but they won’t increase the selling price one bit.

#5: Your spare cash should go into retirement savings
The interest you save by making extra payments tends to get lost in your next property transaction. It would be better to put your share cash into a long-term retirement savings vehicle. You can make tax-free (with certain restrictions) contributions to a retirement annuity.

And then your money will achieve real growth each year until retirement.

#6: Bond finance is “cheap’” money
Before putting extra cash to your bond, consider why you borrowed the money in the first place. A home is a big purchase. And you can only buy it through one of the cheapest sources of money available to you. You can’t do better with a personal loan, bank overdraft or credit card. So let this “cheap” money work for you.

You’re better off paying your bond over its full term.

Let cheap money, leverage, house price growth and inflation work to your advantage and divert your spare cash to a long-term retirement savings plan instead. It’s a disciplined alternative that’ll reward you over the long-term.

Here’s to your financial freedom,

Gareth Stokes
For the Investment Academy