buying a house advice

[SauRoNZA]

The math is more than somewhat out:crylaugh:

Remember that the payment you mention is initially made up mostly of the 10% interest. You would therefore have to add roughly 20% to that to cater for the extra 2 percentage points. That's a cost of roughly R2000pm to fix the rate.

Yes you are quite right, but it's an even better illustration of how much more money you would be volunteering to the bank.

Here are the real numbers off the FNB calculator now that I'm at a laptop.

R 1,000,000 loan at 10% for 240 months = R 9,718.62

R 1,000,000 loan at 12% for 240 months = R11,079.26

R 1,000,000 loan at 10% but repaid as if 12% = 171 month loan term or R444,678.53 saved.

Or R1852.82 per month saved if you want to work it backwards, which is actually R500 more than the additional payments you make each month.

 

[Archer]

"Fix" the rate yourself at whatever the bank would've offered, which means you'll pay off capital, which means if the brown stuff hits the fun you've not only reduced your obligations, you also have some savings that can help float you if you can't afford the higher interest rate. So as it has been said, unless you magically time it perfectly, the few months you spend paying more than you need to hurt you way more in the long term.

 

[Jehosefat]

I'm still surprised as to why fixed rates are not available in this country, it seems to be available in other countries according to Wikipedia.

There could be many reasons for it. I assume that the biggest one is the flexibility offered in home loans here (you can pay it off early, also lots are access bonds) and that makes it very hard for the banks to hedge their interest rate risk on fixed rate loans without potentially massive penalties for early settlement.

 

[Sly21C]

There could be many reasons for it. I assume that the biggest one is the flexibility offered in home loans here (you can pay it off early, also lots are access bonds) and that makes it very hard for the banks to hedge their interest rate risk on fixed rate loans without potentially massive penalties for early settlement.

I hear you and you're correct. Funny thing is that banks actually don't take that much risk when lending money, because the money they lend out is created out of nothing. This is allowed because of the fractional reserve system.

This is how it works:
- You (I'll call you Jeho ) deposit R1 000 000 into Absa,
- Absa reserves R100 000 (let's assume they're allowed to reserve 10%), and lends out R900 000.
- You still see R1 000 000 whenever you check your balance at your ATM or internet banking app, thing is that R900 000 is created out of nowhere in what they call bank credit. So in other words, R900 000 is created out of nothing.
- So there was R1 000 000 in the system before you deposited money into the bank, now there is R1 900 000, R900 000 of which was created out of nothing (bank credit).
- Absa lends R900 000 to Sly to buy a Range Rover. Sly buys from Elon Musk (I'm sure there are a lot of people named Elon Musk in SA ). Elon in turn deposits that R900 000 into FNB.
- FNB has R900 000 in their system. They reserve 10%, i.e. R90 000. They lend out R810 000.
- Elon still sees R900 000 in his bank balance. That's because R810 000 is created out of nothing, or in other words, R810 000 is created so that Elon doesn't think that the bank has lent out his money to other people, or for whatever reason.
- So in two transactions, we have R900 000 and R810 000 created out of nothing. And the bank gets to charge interest on that money. In other words, the bank gets to charge interest on R1 710 000 (R900 000 + R810 000.
- We can carry on.
- FNB lends out R810 000 to Zuma to pay back the money for unnecessary upgrades to his Nkandla house. Zuma instead plans to buy a watch worth the same amount, and deposits that money with VBS mutual bank.
- VBS lends out R729 000 to Malema to pay SARS. Zuma still sees R810 000 in his bank balance. That's because R729 000 is created out of nothing.
- VBS reserved R81 000, lent out R729 000 and also created R729 000.
- Now there is R900 000 + R810 000 + R729 000 = R2 439 000 created out of nothing, but banks will charge interest for that money.
- This can go on and on until technically a total of R9 000 000 is created in the banking system out of nothing, and banks charge interest on that.

The above is how the fractional reserve system works. Hence why I say banks don't actually take risk on their loans.

 

[saturnz]

I hear you and you're correct. Funny thing is that banks actually don't take that much risk when lending money, because the money they lend out is created out of nothing. This is allowed because of the fractional reserve system.

Please, stop.

 

[Sly21C]

Please, stop.

Don't hate the messenger. That's how the fractional reserve system works worldwide. You probably never heard about it. The only difference is the reserve percentage that countries allow. Most allow a 10% reserve, others as low as 5%.

 

[saturnz]

Don't hate the messenger. That's how the fractional reserve system works worldwide. You probably never heard about it. The only difference is the reserve percentage that countries allow. Most allow a 10% reserve, others as low as 5%.

yeah I never heard of it

so tell us under this fractional reserve system, what happens when economic agents call on their deposits?

 

[Jehosefat]

I hear you and you're correct. Funny thing is that banks actually don't take that much risk when lending money, because the money they lend out is created out of nothing. This is allowed because of the fractional reserve system.

I know how the banking system works (I have a degree in Economics and work at a bank) and you are 100% incorrect that the banks don't take much risk. Lets just look up to where they have lent out the R900k non-reserved portion of what I have placed in my account. If the person that they have lent that money to does not pay them back, they are still obligated to pay me back the full R1m that I deposited with them. So they are running the full risk of that person not paying them back.

In order to have the ability to pay me back, the bank has to hold reserves of it's own money (capital or equity in accounting speak) and the amount of capital is relative to the amount of risk the bank is taking and is very strictly regulated (the South African Regulations Relating to Banks are well over 1200 pages).

All this is to ensure that you as a depositor are protected from the risks that the bank is taking.

While you seem to get how fractional reserve banking works, you seem to have a fundamental misunderstanding of risk...

 

[diapason]

yeah I never heard of it

so tell us under this fractional reserve system, what happens when economic agents call on their deposits?

You get a run on the banks like Greece had a few years ago when depositors got spooked and tried to withdraw more cash than their banks available liquidity for.

 

[saturnz]

You get a run on the banks like Greece had a few years ago when depositors got spooked and tried to withdraw more cash than their banks available liquidity for.

so then the bank exposes itself to risk...

 

[diapason]

I know how the banking system works (I have a degree in Economics and work at a bank) and you are 100% incorrect that the banks don't take much risk. Lets just look up to where they have lent out the R900k non-reserved portion of what I have placed in my account. If the person that they have lent that money to does not pay them back, they are still obligated to pay me back the full R1m that I deposited with them. So they are running the full risk of that person not paying them back.

In order to have the ability to pay me back, the bank has to hold reserves of it's own money (capital or equity in accounting speak) and the amount of capital is relative to the amount of risk the bank is taking and is very strictly regulated (the South African Regulations Relating to Banks are well over 1200 pages).

All this is to ensure that you as a depositor are protected from the risks that the bank is taking.

While you seem to get how fractional reserve banking works, you seem to have a fundamental misunderstanding of risk...

Basel II, I think, also increased the reserves that the banks are supposed to hold. Probably, in 2019, Basel III will increase those further.

 

[diapason]

so then the bank exposes itself to risk...

Yes. This was specially highlighted in the 2008 situation where American banks had been lending to sub-prime borrowers and it blew up in their faces.

 

[Jehosefat]

Basel II, I think, also increased the reserves that the banks are supposed to hold. Probably, in 2019, Basel III will increase those further.

Basel II came in in 2008 and Basel III is being phased in from 2014 to 2019. All of the Basel III requirements are already in to some extent.

But in any case, Basel II and III only really mandate capital requirements for 3 types of risks: Credit (will people pay you back), Market (how much will you lose if the market moves against you) and Operational (mostly fraud but also payment errors etc.). Whereas banks are actually exposed to many more risks e.g. concentration risk, liquidity risk, strategic risk, reputational risk etc.

 

[saturnz]

Yes. This was specially highlighted in the 2008 situation where American banks had been lending to sub-prime borrowers and it blew up in their faces.

I'm hoping the very knowledgeable Sly21C could answer since he is such an expert on these things.

 

[Sly21C]

yeah I never heard of it

so tell us under this fractional reserve system, what happens when economic agents call on their deposits?

Watch us and learn then ......

To answer your question, they call it a bank run if we all want our deposits at the same time.

I know how the banking system works (I have a degree in Economics and work at a bank) and you are 100% incorrect that the banks don't take much risk. Lets just look up to where they have lent out the R900k non-reserved portion of what I have placed in my account. If the person that they have lent that money to does not pay them back, they are still obligated to pay me back the full R1m that I deposited with them. So they are running the full risk of that person not paying them back.

In order to have the ability to pay me back, the bank has to hold reserves of it's own money (capital or equity in accounting speak) and the amount of capital is relative to the amount of risk the bank is taking and is very strictly regulated (the South African Regulations Relating to Banks are well over 1200 pages).

All this is to ensure that you as a depositor are protected from the risks that the bank is taking.

While you seem to get how fractional reserve banking works, you seem to have a fundamental misunderstanding of risk...

I disagree with you fully with regards to risk. Unlike you, I have zero tertiary education with regards to economics. I know what I know from reading economic books in my spare time. I'm in the Civil Engineering industry. I think you might have been fed lies by banks, just my opinion.

If a bank lends me R900k to buy a house, they don't take that much risk because they have collateral (the house). They can simply repossess my house and sell it back to someone else so as to recover the loan amount, and then some. If they sell/auction the house at a lower price compared to how much I owe them, they'll simply recover that amount from me personally. If they lend me R900k for me to buy a Range Rover and I skip a month or two, they simply take my car (repossess it). Same thing, if they cannot recover the full amount when the car is auctioned, they'll recover the balance from me personally.

If you're talking unsecured lending, the banks charging a higher interest is more than enough to compensate them from other defaulting debtors. African Bank failing are bankers being greedy. They make more than enough to cover people who can't pay back, they just don't want to part with their money.

The fact is that there's a very large amount of money in circulation that was created by banks, out of thin air so to speak. And they charge interest on it, and you as a depositor don't benefit much.

 

[saturnz]

I have zero tertiary education with regards to economics.

well that settles that then

gg

 

[Sly21C]

Basel II came in in 2008 and Basel III is being phased in from 2014 to 2019. All of the Basel III requirements are already in to some extent.

But in any case, Basel II and III only really mandate capital requirements for 3 types of risks: Credit (will people pay you back), Market (how much will you lose if the market moves against you) and Operational (mostly fraud but also payment errors etc.). Whereas banks are actually exposed to many more risks e.g. concentration risk, liquidity risk, strategic risk, reputational risk etc.

I've heard about these, but I can't comment.

I suspect they're clever terminologies to confuse the public. For example, Obama, the Federal Reserve chairman or his treasury secretary would talk about so called "stimulus packages" to jump start the economy. They referred to them as Quantitative Easing. Very big words, so that the public gets intimidated and therefore believe whatever is said by whoever says it. What QE (Quantitative Easing) all is, is it's just the Federal Reserve printing money, that's all. And American taxpayers have to pay back that money eventually. The American national debt just doubled during Obama's two terms in office (8 years). The reason why the dollar hasn't collapsed (or hyper inflated) like it did in Zimbabwe over 10 years ago and Germany in the 1920s is all because of the Petro Dollar system.

 

[Sly21C]

well that settles that then

gg

Don't be intimidated by economics, it's actually not that difficult. It's made confusing on purpose by bankers so that the public can be made ignorant and therefore be milked. Just because I don't play for Manchester United doesn't mean I shouldn't comment or voice my opinion.

 

[saturnz]

Don't be intimidated by economics, it's actually not that difficult. It's made confusing on purpose by bankers so that the public can be made ignorant and therefore be milked. Just because I don't play for Manchester United doesn't mean I shouldn't comment or voice my opinion.

what makes you think I am intimidated by economics? just because you have no idea what you are on about, doesn't mean that I am intimidated by economics.

tell us again how you reading your books resulted in you coming up with the extremely reckless advice of telling someone to enter into a fixed rate contract when the numbers clearly show this will be an extremely expensive mistake

you going off about certainty in budgets, there is no benefit from knowing that your expenses will certainly be higher

 

[Sly21C]

what makes you think I am intimidated by economics? just because you have no idea what you are on about, doesn't mean that I am intimidated by economics.

Calm down...

I'm sorry if I hurt your feelings. To make you feel better, I only know about the fractional reserve system, nothing else.

tell us again how you reading your books resulted in you coming up with the extremely reckless advice of telling someone to enter into a fixed rate contract when the numbers clearly show this will be an extremely expensive mistake. you going off about certainty in budgets, there is no benefit from knowing that your expenses will certainly be higher

You're being a drama queen, "reckless" is an unnecessarily dramatic word to use. My advise was misinformed because I wasn't aware that mortgage lenders in SA don't offer fixed rates for the full term of the loan. If they did, I would strongly advise the OP to take out a fixed rate mortgage.

I'll repeat that you being scared by the additional 2% on a fixed term is rather short-sighted. But I agree with you that in the context of South African banks and their lending rules (the rule that a fixed rate only applies for 2 to 3 years maximum instead of 20 to 30 years), a variable interest rate is best.