When an applicant is awarded a mortgage bond, the bank automatically registers it with, on average, an additional 20 percent ‘cover clause’ over and above the original loan amount granted.
The extra ‘cover clause’ awarded in a mortgage bond 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
To take a straightforward example, a R1 million loan will be registered with a R1.2 million bond. Mike van Alphen, national manager of Rawson Finance says this R200 000 ‘cover’ amount can cause alarm among bond applicants because they think they are being given – and will be charged interest on – a sum larger than they asked for.
This is a misconception and it is definitely not the case, van Alphen says.
“The extra ‘cover’ is not for the client’s use, nor is he charged interest on this extra amount."
The extra ‘cover clause’ 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, van Alphen says. When a bank needs to take action against a borrower it incurs legal costs. The 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 percent on the bond,” he says.
He adds that this ‘cover clause’ should not be confused with the 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 buy 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 apply for an additional advance in the future and won't have to go through another bond registration process providing the new total bond amount does not exceed R1 million.
Van Alphen says this is usually done when the buyer knows he will need funds to upgrade the home and intends to at an early stage. By requesting the registration for the extra sum as part of the original bond, he will save 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 is that on the extra amount, the client will pay interest only when the application for the advance to do the upgrade is granted and dispensed by the bank, van Alphen says. Furthermore, he will only be charged on the sum he 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.
Van Alphen says this provision by the banks should encourage bond applicants to undertake improvements early on if they can possibly afford to do so. He says their experience is that every Rand spent on an upgrade will usually add R2 to R3 to the value of the home. "Money invested in property, therefore, very seldom goes to waste.”
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