Warning: Home Loans Promising Upfront ‘Payback Holidays’

A groundbreaking home loan option from FNB, described as a ‘market first’, is likely to attract graduates and young professionals eager to buy their first property, yet it comes with various potential risks.

It is essential to understand the specific trade-offs involved and how they could affect repayments over the course of the loan.

Read: Homeowners in mortgage default have rights, according to court

The bank’s offering for individuals under 35 (with an NQF Level 5 qualification or above) includes what it calls “valuable benefits,” such as:

1. No capital repayments for the first two years;
2. A tailored and competitive fixed interest rate for the first 24 months;
3. A loan up to 110% of the property’s value;
4. An “easy repayment transition after two years”;
5. Flexible loan terms of up to 30 years; and
6. A 50% discount on bond attorney registration fees.

The first two of these “benefits” may appear attractive, but they lose appeal upon closer examination (more on that shortly).

Additionally, three of the mentioned benefits (excluding the easy repayment transition) are available to most home loan applicants at the bank and are not exclusive to this offering.

For example, the 50% discount applies to all applications made directly through nav » Home on the FNB app.

Generally, borrowing up to 110% of a home’s value means you are combining purchase-related expenses (such as bond registration fees, property transfer costs, transfer duty, and deeds office levies) into the loan, which you will repay—along with interest—over the life of the mortgage (typically 20 years).

This strategy is also unwise, as it may leave you “underwater”, meaning you owe more than your property’s worth.

The initial capital repayment holiday is appealing because it allows for lower monthly payments for two years; however, it does not contribute to any equity during that time.

For a R1.5 million home loan against a property valued the same, the outstanding amount remains R1.5 million after 24 months. This leaves only 18 years (on a 20-year mortgage) to pay back the principal, resulting in higher monthly payments due to the shortened repayment timeline.

In this hypothetical case, based on average repayment rates (normal repayment at prime (currently 10.25%) + 1%, assuming stable interest rates—an unlikely scenario), our borrower will repay a total of R3.77 million, of which R2.27 million is interest over the 20-year span.

The expected monthly repayment is around R15,700, not factoring in additional fees. Clearly, choosing an interest-only payment for the first two years will lead to reduced monthly expenses.

Even with a similar interest rate, this payment would be approximately R14,000—yielding a saving of R1,700. However, FNB is offering a “more tailored and competitive fixed interest rate” for this period.

If we assume that our buyer receives the prime rate (which is quite competitive!), this would lower their repayments to R12,800 over the 24 months, nearly R3,000 less than their conventional payments.

However, deferring the principal owed for 24 months will lead to an extra R35,000 in interest paid over the entire loan duration.

A lower initial monthly payment of R3,000 can significantly aid this household’s cash flow. But will they be able to handle a nearly R3,500 increase after two years?

FNB notes a “smooth repayment transition,” but provides scant details.

This is likely similar to accommodations provided by banks to homeowners facing difficulties during job transitions (akin to payment break programs during the Covid-19 pandemic).

Read: Covid-19 payment holidays lead to increased credit balances and delinquencies

What will likely happen is that the repayment amount will rise over three to six months, starting in month 25.

This could potentially result in an even higher monthly payment for the remaining loan duration since less capital would have been repaid by month 31 than would have otherwise been the case.