Let’s talk home loans. In South Africa, home loans (also known as mortgage bonds) are typically based on a variable interest rate, linked to the prime interest rate as published by the Reserve Bank.
For example, if the prime rate is 8.25% per annum, the bank may give someone with a good credit score a rate of prime less 0.5%. This makes their initial borrowing rate 7.75% per annum. ‘Initial’ because the prime rate can change up or down, which affects your borrowing rate and the instalment (or interest) you have to pay each month.
For a 20-year home loan, the bank calculates what you should pay each month to settle the loan over the period. Your monthly repayment is made up of two building blocks: interest (the cost of borrowing) and capital (the amount borrowed).
How much interest do you end up paying?
If you’re not able to pay more than the monthly instalment the bank calculates — in other words, you pay off the loan over the full 20 years — the table below shows how much interest you’ll pay on loans of increasing size. Remember, interest is what you pay over and above the loan amount.
No, our maths isn’t wrong: the amount of interest you end up paying over 20 years is more than what you borrowed in the first place! And if the prime rate goes up, so will the interest you pay…
Eek! How do I pay less interest?
Pay more than the monthly instalment if you can afford to. If you have an access bond, you can also ‘park’ funds in your home loan account instead of leaving that money in your cheque account. Interest on a home loan is calculated daily based on the outstanding balance at the end of each day. By reducing the outstanding balance, you pay less interest. (And because it’s an access bond, you have peace of mind that you can still access the extra money if you need it.)
Contributing more than what’s required will allow you to pay off your home loan over a shorter time. Here’s how much interest you’ll save:
Being able to put an extra R4,000 per month into your access bond will allow you to pay off your home loan in almost half the time, and you’ll save more than R500K in interest!
Should I invest my extra money or pay extra into my home loan?
Ah, the big question… Unfortunately, there’s no easy answer — it depends on so many variables and will differ for each individual.
A key point to understand when making this decision for yourself is investment risk. Parking funds in your access bond effectively gives you a guaranteed, after-tax, risk-free ‘return’ of the interest rate on your loan. Very few investments out there can do that. (Low-risk investments will typically return less than what you’re paying on your bond.)
Obviously, it’s also important to invest. You need to save for retirement, for example, which can also help you pay less tax.
Consider chatting to a financial planner who will be able to advise you on the best all-round strategy, taking your personal circumstances into account. Get that ball rolling — your future awaits!