Smart property investors will be aware that paying off a bond faster will save hundreds of thousands of Rands in interest and shave years off the bond term. But, like all bondholders facing tight budgets, buy-to-let property investors may not see their way clear to find a few hundred Rands extra every month to accelerate their bond repayments. However, the passive income generated by a buy-to-let property makes it quite easy to pay off a bond in half the time, without taking any further cash out of your pocket each month.
Let’s take an example of a R500 000 property that was acquired with a 100% bond at an average interest rate of 12% over 20 years, and a rental of R5 000 a month. This produces a monthly shortfall (the difference between the rental income and the property expenses), which is funded by the investor, of around R1 800 a month for the first year.
However, this reduces to R1 500 in the second year, R1 200 in the third year, R850 in the fourth year and R475 in the fifth year, because the rental increases each year. Thereafter, the property breaks even (the monthly rental income exceeds the property expenses) and the property begins to generate an ever-growing monthly profit. This profit can be used to pay off the bond in record time.
Reinvest rental surpluses
If this ever-growing monthly profit is reinvested into the bond each month, the investor will pay off the bond in just 12 years, shaving eight years off the bond term and saving R506 500 in interest payments. Half a million Rands in savings and owning a bond-free property within 12 years will significantly boost any investment portfolio. And it would require no extra cash from the investor’s pocket.
Maintaining the shortfall payment
Another option is to maintain the R1 800 shortfall payment that the investor made in the first year. In other words, instead of paying the reduced shortfall each year, the investor maintains the R1 800 per month payment each year, even after the property breaks even and he begins to receive the monthly profit. In this way, the property will be paid off in 11 years, and he will save a massive R545 038 in interest while also pocketing the profit produced by the property.
Double the impact
The third, and most effective, option, for those who want financial independence soon, is to combine these strategies by both reinvesting the rental income surplus (after the property breaks even) and continuing to invest the R1 800 initial shortfall into the bond, even after the property breaks even.
Investors who do this will pay off their bond in just nine years, and will save a whopping R622 114 in interest – the value of another entry-level buy-to-let property.
The annual reduction in the monthly shortfall, the breakeven point (when the investment becomes cash-flow positive) and the Bond Optimiser feature, which allows investors to calculate the impact of reinvesting the rental surpluses and continuing the initial shortfall payment, are just some of the crucial factors that have been incorporated into the P3 Property Wealth manager software.
This article “Annihilate Your Buy-To-Let Bond” was issued by Real Estate Investment Magazine.