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The beauty of borrowing money is that, unlike when you're making deposits, you don't have to worry about the credit rating of the counterparty.

Bond Originators

Using retirement funds to pay off home loans

Our archaic investment framework guarantees questionable behaviour, like saving at the same time as being in debt. I'm a prime example of this stupidity, having spent a decade paying punitive rates on a massive homeloan, at the same time as being prevented from using my retirement savings to pay off my loans (even more insanely, some people have a home loan at the same provider they've got their retirement savings with!). The only way to access my savings would have been to resign from my job (!), and then I'd be hammered with tax if I wanted to make the sensible decision to use my savings to pay off my loan.

A simple example of what's sensible

Let's take an example of somebody who's saved up R500,000 in their retirement fund and has R500,000 outstanding on their home loan. The sensible thing for all but the most aggressive of investors would be to pay off the home loan with their retirement fund money. BUT doing this whittles down fees to financial institutions to nothing - asset managers can no longer charge their asset managment fees on the R500,000 retirement savings as it's been used to pay off the home loan, and the banks can no longer charge fees on the R500,000 home loan as it's been paid off.

Banks & asset managers profit nicely

Allowing people to use their retirement savings to pay off home loans would massively reduce the profitability of banks and asset managers in South Africa (and long-term insurers, as they also supply some of the savings products). And that is why it is unlikely that government will relax this restriction in my lifetime - companies are mandated to maximise profit, and the lobbying power of the financial services industry is mighty. It's not surprising for instance to read that ABSA's position is: "You need to pay your debt and on the other side have money earmarked for your retirement and other savings." - it would be an absolute disaster for ABSA's profits if masses suddenly paid off their home loans.

Why using savings to pay off debt is smart

I've hinted at one of the reasons why it's smart to use your savings to pay off debt, but now I'll be more direct about the reasons, so that there's no doubt.

Massive saving on fees

There's a massive saving on fees. The exact savings will depend on your individual circumstances; in particular what asset management fees you're paying, what rate you've negotiated on your home loan, the size of your savings relative to your home loand and the period over which you manage to repay your home loan. It wouldn't surprise me to see somebody paying away a fifth of their savings in the form of fees over 20 year period to banks, asset managers and others involved in the feeing frenzy.

Avoids a dangerous leveraged investment strategy

The savings on fees is obvious, but a more subtle issue is that paying off your debt derisks your investment position. Being in debt at the same time as investing increases your risk profile, "gearing you up". If you suffer a 10% loss on R100,000 savings, you're left with R90,000; but if you have a home loan of R0.9m and suffer a 10% loss on your R1m savings, you're left with nothing (R1m*0.9 - R0.9m = R0). Of course this could work the other way as well, but that's a gamble.

Here's what Warren Buffett thinks about leverage/borrowing: "Unquestionably, some people have become very rich through the use of borrowed money. However, that's also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you're clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people."

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