Debt: Good or Bad? (The Bugle)

I often find it surprising how low the average approved mortgage bond is when our house prices are generally more substantial. Ooba, South Africa’s leading mortgage originator, recently reported that their average approved bond size is only R818,955. This is on an average purchase price of R947,086. First time buyers currently represent 25% of all buyers in the market, but according to Ooba make up 51,3% of all Ooba’s bond applications. This is incredible and gives us an understanding of how key this segment of the market is. If you are a mortgage originator or finance provider your product offering would therefore be tailored to a large extent to address this first time buyer market. The average age of an Ooba applicant is 37, and 47,5% will be declined by the first bank they make application to. However, 27% of those who are declined by one bank will be approved by another, meaning that Ooba’s effective approval ratio is 65,3%.

We know that currently total South African household mortgage balances are R816,7bn, growing at a subdued rate of only 2.3% year-on-year. This represents 72,6% of all mortgage balances in the country indicating how important residential mortgages are in the bigger picture. I regard mortgage debt as generally “good” debt, as it is typically long term in nature and used to finance a growing asset. However, households borrow money for more than just mortgages and 41% of all household credit balances (i.e. their debt) are in non-mortgage related finance such as instalment sales, leasing finance, overdrafts, credit card debt, personal and micro loans. Unsecured lending that grew exponentially during 2012 has fallen back dramatically, much to the dismay of micro-loan finance providers such as African Bank and Capitec. Economists are however relieved as the perceived bubble in unsecured lending was like a time-bomb waiting to explode. Unsecured lending (general loans and advances, credit card debt and overdrafts) is typically on consumption expenditure and this makes it dangerous and the type of debt I would refer to as “bad” debt. This type of debt is still growing at 7,3% year-on-year but significantly down from the 31,6% recorded in November 2012. 

So when is debt “good” and when is it “bad”? The beauty about investing in property is that there exists a mortgage bond market to readily finance this asset class at reasonably competitive interest rates and terms. This allows you to easily buy an asset with part equity (cash) and part debt and thereby leverage your purchasing power. It is good when used in a way that matches your ability to service the debt. You should always consider a “what if” scenario – if you had to sell the property quickly by reducing the price, would you still be ahead? You would be if your loan to value ratio was relatively low, say 50%, and kept at these low levels as part of your long term investment strategy. Once you have a property with an access bond facility active on it, this becomes an excellent savings vehicle as the effective rate you earn by depositing extra cash into the mortgage facility is equal to the bond rate, currently at 9%. 

Published in The Bugle, 2 July 2014. Author: Andreas Wassenaar