Put It In the Bond?

If you’re servicing a mortgage at the moment, and you happen to come into some money, the “best” advice you’re probably going to get is: “put it in your bond”. Not bad advice, i guess, but i’m not so sure it’s the “best”.

**DISCLAIMER: I’m NOT a financial advisor; am not pretending to be one; and certainly not qualified to be one. But i can kinda do the numbers, so this looking at it purely from a mathematical perspective.

When it’s not really the “best” advice is when you are servicing other debt, at higher interest rates. Then the numbers say: kill that debt first, and _then_ look at the mortgage. So if you’re servicing a credit card, overdraft or vehicle finance (which can typically be higher than prime) and your mortgage is sub-prime, service the higher first.

But more personally, i recently faced the opportunity of trading in my vehicle for a newer one (which would have been nice) and i was figuring out what to do with the trade-in amount and work out where it would best pay dividends. On an aside, i’m of the opinion that buying a vehicle is NOT a financially smart move at all- no matter how you try slice the numbers. You will always lose (and i’m not referring to collectors’ classics). So look after your car- treat it nice, drive nice, service it regularly so you can leave it in your will. After all, it’s __just__ a car, right 😉

So down to the maths… Note: the numbers have been changed slightly to protect the prudent.
New car: R150k at 15.5% APR over 60 months.
Existing debt: R640k mortgage (±30 months into the schedule) at 14% APR over 20 years.
Trade in on car: R50k. What to do with the R50k? A) Plough it into the bond. B) Use 100% of it as a down payment on new car. A or B, what do you do? The “best” advice i received was plough into the bond and save thousands in interest on the bond! Uhuh. That’s half the truth.

As a down payment on the new car, I reduce the repayments from R3.6K to R2.4K, and end up saving, in effect, R44k in interest over the term. Not bad, not great.
In the bond, i reduce the interest _over the same term_ by R33K. Worse. But not a surprise. And that’s the important part here: the same term. 60 months. You see, over the remainder term of the mortgage, that advance payment will save you A LOT! But now you’re comparing a value of money of two different terms: 60 months versus N years on the mortgage, so don’t be too surprised if you draw bogus conclusions. Afterall, once you’ve finished paying off the car, you’re R3.6k deeper in the pocket which you can then plough into the mortgage anyway.

So, on face value, it’s more favourable, over the same term, to service the vehicle as quick as possible and then see to the lower interest obligations. But there are better options… which is the other half of the truth: discipline.

Add in some fiscal discipline into the mix, and suddenly your options are wild. For example…

Put down the down payment on the car, saving an extra R1.2k in repayments each month on the car, but then put the saving into the mortgage over the same term. Suddenly you start to save R64K in interest. Mmmm… Or…

And then there’s this. Which really was the best option (Thanks, A)…

Take your old car for a shmancy valet at about R200, pretend it’s new and “pay for it” anyway at R3.6k per month. Now you’re saving close to double your previous best!

The bottom line is; if you’re in the market for a car and can afford X, but you’re servicing other debt, service that debt first- forget about the car*. Unless it’s an absolutely necessity (and looking better than the Jones’ is not a necessity- i checked) you probably don’t need it.

*Forgetting about the car, probably anywhere in the world, is really hard to do though. In South Africa, households spend a disproportionate amount of their disposable income on vehicle financing, which says a lot about how we feel about our cars. Somehow, cars have so (too) much appeal. So much so that having 4 reliable wheels is just never enough. There’s always going to be something really “cool” about a car that makes you just wanna have it. And the price tag is just irritating. Can you say X-Trail… or Fortuner? 🙂