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Should you put down a deposit when financing an investment property?

Reader’s questions answered.

CAPE TOWNIn this advice column Tshireletso Rakgori from Alexander Forbes answers a question from a reader who wants to know if he should put down a deposit on an investment property he is buying or rather invest the capital elsewhere?

Q: I have R100 000 in my savings account. I’m currently buying an investment property and would like to use the money for deposit to get the monthly payments down. The banks offered me a 0.05% improvement if I make that deposit and the monthly repayments will then match the rental income.

My fiancé thinks I should rather take that money and invest it elsewhere where it can earn higher interest. What would you advise?

Paying a deposit towards a mortgage bond can make a significant difference. A mortgage is a major financial burden and reducing it can have immediate benefits.

Buying a house via a mortgage bond essentially entails making two kinds of payments. The first is to repay the capital amount, which is usually the purchase price of the house, and the second is to repay the interest that the bank charges over the period of the loan. During the first years of the mortgage bond, the largest part of your repayments goes towards paying the interest, making the reduction in the capital amount quite small.

How this works is that the deposit you pay upfront reduces the mortgage bond you owe. Therefore a smaller bond is required, which in turn reduces the amount of interest you pay.

To make the above more clear, consider the following:

Let’s say for example the property you are purchasing is R1 200 000. If you take out a bond with no deposit at a 10.25% interest rate, you will pay R11 779.72 per month over 20 years. At the end of the bond term, you will have paid back R2 827 132.95

On the other hand, if you could put down a R100 000 deposit, the monthly repayments will be R10 798.08, and the total repayment will be R2 591 538.54. If the deposit is added to this, the total still only comes to R2 691 538.54. In other words, you would save R135 594.41.

In paying the deposit you therefore not only get the benefit of having the expected rental income match the loan repayments, but you also get to save on some of the interest that the bank would have charged over the years. The other benefit is that the mortgage will be paying itself essentially from your rental income.

The benefit is therefore immediate and could help you to meet your cash flow needs in the short term. In the long term you would also benefit from the capital growth on the property. Being a primary human need, housing is always in demand and if you have chosen one in a good area, you should see growth in value at least linked to inflation.

Overall, property is a great investment, however if you are going to acquire it through a loan you want to do your best to minimise the loan as well as the term of the loan to save on interest. That way you can enjoy more years of earning rental income that will be coming into your pocket instead of it going towards loan repayments.

Tshireletso Rakgori is a financial planning consultant with Alexander Forbes in Johannesburg.

If you have any questions you would like answered by financial planning experts, please send them to editor@moneyweb.co.za.

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Hang on, so you are saying that your R100,000 is going to save R135,594 in a 20 year period?
Something must be wrong with that maths. A money market account would give you more than that!
R100,000 x 10.25% over 20years compound is more than R700,000
Did i misread something?

First of all, the total amount paid is R 2 591 538.54 and not R 2 691 538.54 all things being constant. So that gives you an overall ‘saving’ of R 235 594.41.

What the article fails to mention is that because your capital amount is reduced after every payment made, the ‘interest saving’ also decreases every month. You are not earning interest on the R 100 000 deposit, you are just saving interest on an every reducing amount.

If you invested the R 100 000 @ 10.25% for instance, the capital amount is going to compound, therefore giving you a total FV of about R 770 000. So by all means, if you are able to invest the R 100 000 @ 10.25% compounded over 20 years, it is something to consider.

it is very simplistic just to look at the interest savings. As an investment there will be income tax implications as well. It might be better, depending on income tax situation, to invest the funds, pay more interest and deduct the interest paid from income derived from the property.

I do not agree with article.

From a pure investment point of view it is more beneficial funding the investment property with a 100% loan and rather invest the cash ‘deposit’ in shares, unit trusts, etc. Deposit only makes sense from a cash flow perspective. If cash flow is not a problem, invest cash amount in shares, ‘maximise’ loss (rental income – expenses) and re-invest tax return in shares, etc. This way you will maximise your financial investment. Do the sums and you will be surprised how much you can maximise your investment.

The article is assuming that cash flow is all that matters and did not evaluate what I’ve described above. I have 4 investment properties. I keep cash deposits to a minimum (primary goal of deposit is for cash flow purposes, but is gradually reduced over time). Cash is invested in shares, tax returns are reinvested in shares, etc. Every year I explore ways to maximise tax returns from my investment properties (legally). Suggest that you do your homework before following advice of the article.

This is another reason why I will never use a so called financial advisor

Agree 100% with AP. For investment property interest is a deductible expense.

The logic of this adviser clearly lacks some vision. I wonder if he owns any property of any significant value. Yes, property is and can be a great investment. But the advice here fails to reveal many things an investor should consider such as the tax implications of this deal, the capital gains tax when selling the property, the cost of maintaining the property, rates, taxes, insurances, the risk of a tenant not paying for a few months, the damage the tenants cause, general wear and tear on properties over 20 years. Changes in mortgage interest rates also are not taken into account, just to name a few things that came to mind in a few moments. I bet there are lots more.

There is much more advice that would one necessary to make an informed decision. Frankly, the advice in this article sucks and I would not pay a bean for it. Financial advisers tend to be armchair millionaires. In my experience, I would expect much more than mediocre advice from someone who claims to be a financial adviser.

Anybody thinking of investing in residential property at the moment is a fool.You’ll be lucky to get rent of 8% of the property value and that’s if the tenant pays.The effective interest rate you’ll be paying your bank is somewhere between 11 and 12%, interest rates are going higher and we haven’t even taken into account any of Sweetpea’s extra charges!

A further discount of 0.05% on a bond of R1.2million is R50 extra saved per month. If that’s the shortfall to make the property pay for itself, just increase the rent by R50, tell the bank to stop playing silly mind games and shop around for a better offer. Some liquidity will probably be more valuable going forward.

Think the 0.05% is a finger issue,should read 0.5%.

I would try to get a 100% loan. If possible, I would then deposit it as an excess deposit which would be available if needed. You would thus earn/save the % interest that was charged on the deposit . In most cases it would be prime. In a normal savings account/call account you would not be able to get that kind of savings rate.

End of comments.

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