Last week I showed why it was not a good idea to buy a home loan-linked endowment policy.
The products are sold on the basis of using the money you would have used to pay off the capital on your home loan to nvest in an endowment.
The theory is that after 20 years your endowment policy investment will have grown sufficiently to enable you to pay off the capital and still have a bit left to buy a few helpings of caviar. But, you do have to pay the interest on your home loan at all stages.
The theory is great as long as there are low home loan interest rates and high returns on endowment policies. Last week I showed why this theory just did not work at a time of high interest rates. Even if the interest rates are low no one can predict what they will be in the future.
But, there is another option. Steven Heilbron, lending manager at Investec, says there is a flexible package that you can use to your advantage through unit trusts. The key to Heilbron's option is flexibility and transparency. Against this, he says, investment in assurance endowment policies can be onerous and costly.
As mentioned, the endowment option would work if you could be sure that for the 20 years, home loan interest rates would remain low and returns on the endowment policies stayed high. Unfortunately, both interest rates and returns on investments are volatile.
This is where Investec's unit trust-linked system has its strength.
It works like this: If interest rates are low, then you can choose not to pay off the capital on your bond, but invest the equivalent into unit trusts. As a rough rule of thumb you would have to take the average growth on the unit trust of your choice over five years. If the projected rate of growth on your unit trust of choice was higher than the home loan interest rate, then you would opt for the unit trust investment.
As unit trusts are not a short-term investment, their performance should always be evaluated over a three- to five-year period. If, after this time, the market is not out-performing the cost of debt, you may then choose to stop investing in unit trusts and rather pay the money off on the capital part of your home loan.
There is risk involved and it requires the discipline of not drawing on the capital build up. If you want to go the route of not paying off the capital amount of your home loan this is a far better idea than the endowment option.
While on the issue of home loans beware how you use a variable balance mortgage bond (loans which operate like bank accounts, on which you can pay off extra or borrow more).
A colleague of mine was rather confused the other day. Her story went like this (I have altered the figures for the sake of simplicity): She had borrowed R100 000 and paid her monthly payments on time for five years. At the end of five years she made a big price item purchase. To finance her purchase she increased her access bond back to R100 000.
Then came the problem: she continued to pay exactly what she had been paying every month before she had pushed the loan back to R100 000. What she had forgotten was that the R100 000 now had to be repaid over 15 years and not over the original 20 years.
The result of a shortened repayment period is that you pay more interest over the shortened period. In other words my colleague should have increased her monthly payments to cover the higher interest bill or she should have spoken to her bank manager to increase the repayment period.