Understanding mortgage bond 'cover clauses'

To take a straightforward example, a R1 million loan will be registered with a R1,2 million bond. This R200,000 'cover' amount, says Mike van Alphen, national manager of the Rawson Property Group's bond origination division, Rawson Finance, can cause dismay and alarm among bond applicants because they think that they are being given, and will be charged interest on, a sum larger than they need or asked for.

This is a misconception, says van Alphen, and it is definitely not the case: "The extra 'cover' is not for the client's use, nor is he charged interest on this extra amount," says van Alphen.

The purpose of the 'cover clause'

"It is there as a safeguard to protect the bank if and when the bondholder defaults and the outstanding loan amount reaches a level above the original amount that was granted. When a bank needs to take action against a borrower it incurs legal costs. These legal fees, as well as accumulating interest debits to the bond account, can cause the amount of the outstanding balance of the bond to exceed the loan amount that was granted. With the 'cover clause' in place, the bank can legally sue for the total outstanding debit because it will be 'covered' by the additional 20% on the bond," says van Alphen.

This 'cover clause', he adds, should not be confused with those extra amounts that can be registered when the applicant applies for the first bond on a property that has been purchased. For example a client requiring a bond of R750,000 to purchase a home, can request the bank to register a mortgage bond of R1 million. The extra R250,000 will be held in "reserve" and the client may then apply for an additional advance in the future and will not have to go through another bond registration process providing the new total bond amount does not exceed R1 million.

This, says van Alphen, is usually done when the purchaser knows he will need funds to upgrade the home and intends to do so at a relatively early stage. By requesting the registration for the extra sum as part of the original bond, he will save substantially on the bond registration fees charged. If, for example, he later applies for a second bond, the cost of the two together would be higher than for one application.

The good news, says van Alphen, is that on the extra amount, the client will pay interest only when the application for the further advance to do the upgrade is granted and dispensed by the bank. Furthermore, he will only be charged on the sum he actually takes out: if he registers an extra R250,000 mortgage bond, but only draws R100,000, he will be charged interest on the latter sum only and this amount will be added to his existing bond balance.

"This provision by the banks," says van Alphen, "should encourage bond applicants to undertake improvements early on if they can possibly afford to do so. Our experience is that every Rand spent on an upgrade will usually add R2-R3 to the value of the home. Money invested in property, therefore, very seldom goes to waste."

For further information contact Mike van Alphen at az.oc.ecnanifnoswar@ekim.