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Wednesday, February 11, 2009

Bond, Bankrupt Bond: The costs associated with bonds

By Graham McKenzie

Buying property could closely resemble birth of a loved one. It's very painful and confusing at first, but a joy and celebration the longer life is lived. Buying property and taking out a bond to finance that purchase is a long, roller coaster ride. Statistics show that people who buy property and sell it within five years lose money, and sometimes it's a lot of money.

The problem begins with the costs associated with buying property and the high risk nature of a home loan or bond. Owning property is considered a future investment, not a quick way to make money.

The actual costs of taking out a bond in relation to the total costs involved in the act of buying a property are not that high.

Several fees are associated with bonds, which include registration, initiation, and conveyance fees. Value added tax also comes into the picture. Add up all these charges and you begin in some debt.

The fees are covered, but should exceed a rate of more than 3% of the total cost of the property. If the property appreciates in value like it should, the cost will be recovered within the first year or so.

However many people do not consider the minor details and purchase property on instinct. If they sell back within five years they lose a lot of money because you spend the first third of the bond paying back interest and not principal. The result is a lot of money still due.

For example, buy property at $600,000 and sell back within five years. If you've only paid $30,000 in principal, which is a likely scenario, you still owe $570,000. Can you cover that?

The bank also must find ways to cover a large bond. Often they borrow from a central bank. If the small, more local bank hits a rough patch, it will request some relief from the central bank. The central bank may allow the bank to enter a "grace" period with the bond, which means they will pay principal and no interest for a pre-defined amount of time. This does not come without penalties though.

If you are thinking about purchasing property make sure you think about it thoroughly. This should never be a spur of the moment type of purchase. Bonds are great for the long-run, but horrible for short investments.

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