A Fin24 user wants to know if he should put an extra lump sum he has available towards his home loan, his car finance or elsewhere. He writes:
I need some advice on investments.
The only debt I have is a home loan and vehicle finance. The balance on my home loan is R460 000 at 7.55% with a balance of seven years and eight months remaining. The balance on my vehicle finance is R132 000 at 8.75% and a balance of 20 months remaining.
I have R300 000 that I want to invest. Do I do a down payment on my bond, which will reduce it to R147 000 and thus saving of the repayment?
Do I purchase a second property for about R500 000 and rent it out? Or do I invest the money elsewhere?
I am 40 years of age.
Aurum Trust expert Gustav Potgieter CFP® responds:
You are still relatively young and it is good to see you are money savvy. Unfortunately, I do not have information like your tax rate and instalment on the bond.
I, therefore, made some assumptions, namely a tax rate of 35%, a remaining period of bond 92 months and a bond repayment of R6 600 per month. Your debt, home and car, have both relatively short periods left, so most of the interest has been repaid.
Let's start at the easy part. A down payment on your bond gives you a "guaranteed" investment rate on your capital.
Your bond is paid with after-tax money, so, to get your pre-tax return, you have to divide the bond rate by 0.65 (1 minus your tax rate) = 11.62%.
If your tax rate is higher, the percentage will increase and vice versa.
If you make the down payment and decrease the payment over the remaining period (92 months), your instalment will be about R2 450.
You have the following options (comparing apples with apples):
- Make a down payment of R300 000 on your bond and keep on paying the current monthly instalment of R6 600. The bond will be repaid in about 58 months.
Invest the R 6 600 (bond repayment) for the balance of 34 months - outstanding period of 92 months minus 58 months. Using the "guaranteed" return of 11.62%, you will have R264 250 available.
- Make a down payment on your bond of R300 000 and drop your instalment to R2 450, so that your bond will still be paid off of in 92 months.
Invest the drop in instalment. Using the "guaranteed" return of 11.62%, you will have
R611 500 available.
- Take the R300 000 and invest it in a growth investment. The "guaranteed" return is a realistic return over 92 months and the market can even outperform that, but comparing apples with apples, your R300 000 will be R728 050, using the same "guaranteed" rate as above.
Why does the lump sum do better:
- Your bond rate is low;
- The 8th wonder of the world, according to Albert Einstein: Compound
I personally do not like buy-to-let residential property for the following reasons:
- Low returns on residential property - on average between 4% to 8%, depending
where it is located;
- Ongoing maintenance;
- Tenant problems like vacancy and non-payment of rent;
- Tax on the netto rental income, with my assumptions meaning that you only get
65% of the rent after tax;
- No control over rates and taxes;
- Low liquidity - it takes time to sell the property, and the associated costs.
Invest the R300 000 in a growth investment (unit trust platform), with a spread risk, in terms of local and off-shore and type of funds that will suit your needs.
The main benefits being:
- Liquidity within about a week;
- No term, like with an endowment;
- Possibility of tax friendly income during retirement;
- Flexibility in terms of fund choices.
I have ignored capital gains tax (CGT), for the simple reason that it would be applicable in
I strongly advise you to speak to a qualified, experienced financial adviser, preferably a CFP, to assist you. The decision should be easy, but the crux of the matter is the funds that you choose.
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