The stubborn home loan debt

The stubborn home loan debtThe first few years of paying off your home loan can be a very disheartening experience. Despite paying in thousands, if not tens of thousands of rands each month, the amount you still owe hardly budges.

In the first few years interest makes up a very large part of the repayment. This is because of how amortisation works. Amortisation is the process of spreading the loan repayments into a series of fixed payments so that the loan is completely paid off by a specific date.

“As each monthly payment is made, part of the payment is applied as interest on the loan and the remainder of the payment is applied towards reducing the principal,” explains Ewald Kellerman, chief risk officer at Absa Home Loans. The amount allocated between interest and principal debt (capital) varies each month.

Listen to Maya and Mapalo Makhu discussing this and other topics in the My Money, My Lifestyle podcast.

At the beginning of the loan, interest costs are at their highest. For home loans, where you are paying off the debt over 240 months, initially the majority of the payment is towards interest and you only pay off a small amount towards the principal debt. As time goes on, more of your payment goes towards the debt and you start to pay less interest.

In the example provided by Absa home loans, on a R500 000 mortgage, by the end of the first year you would have made a total repayment of R59 903 (R4 991.90 per month).

However, of this amount, R51 609 went to interest and only R8 294 to capital. So, by the end of year one, your outstanding debt has only reduced to R491 706.

In the fifth year, only R12 328 goes to capital. By now you have paid nearly R300 000 into your mortgage, but the balance has only reduced to R451 593.

It is only after 13 years (by month 160) that the amount that is allocated to the capital equals the amount paid to interest. By this point the outstanding mortgage would be around R280 000. From here on, however, the outstanding mortgage reduces significantly each month as an increasing amount of your repayment goes to the principal debt. In your final year, nearly all your installment goes to the principle debt with only R2 748 paid in interest.

How to reduce the debt sooner

If you want to reduce your outstanding mortgage sooner, then you need to pay in more each month. Every single extra rand you pay goes directly to paying off the principal debt, as the interest is already deducted from your agreed monthly installment.

As you only pay interest on the outstanding debt, by reducing that debt with extra payments, you drive down your interest costs. This means a higher percentage of your agreed monthly installment starts to go to capital repayment. This creates an acceleration effect which is why even a small amount like R500 a month can help you pay off your home loan several years earlier.

Using the same example, if you paid the extra R500 per month, by the end of year one your capital would have reduced to R484 693.

This means your outstanding balance has been reduced by R7 013 more than if you had made no additional payment. Although you had made only R6 000 in additional payments, the extra R1 013 reduction is due to less interest as the balance has reduced. This means that a higher percentage of your normal monthly installment has gone to principal debt.

By year five, your balance would have reduced to R412 358 – that means you owe R39 235 less than if no additional payment was made. In this case your additional payments over the last 60 months only came to R30 000. So, you have already saved R9 235 in interest.

Home loan debt repayments table

By paying in the extra R500 per month, by year 16 you would have paid off your mortgage – in comparison if you made no additional payments you would still have an outstanding balance of over R220 000.

The rule with any debt is that the more money you pay, the less interest you owe. The longer you take to pay off a loan, the more you will spend on interest.

Credit line

The other benefit of paying extra into your home loan is that it can act as a credit line at a later stage. Most credit facilities on home loans reduce in line with your agreed repayment schedule, but if you pay in extra you are able to access those “pre-paid” funds at a later stage.

Speak to your bank

If you are paying in extra to your mortgage, it is worth informing your bank. While the extra funds will be allocated to the principle debt, depending on your home loan agreement, the bank may reduce your monthly installment so that you are still paying off the loan over the agreed 240 months. Ask the bank to keep the installment the same so that you can accelerate your debt reduction.

This article first appeared in City Press.

31 CommentsLeave a comment

  • I need to take out a home loan on unbonded property together with my sister and my spouse. The property is in my sisters name, is it possible?

    • FNB Spokesperson: Buyisile Maseko, Growth Head, FNB Gold Segment

      “I need to take out a home loan on unbonded property together with my sister and my spouse. The property is in my sisters name, is it possible?”

      As the owner (sister) previously cancelled the bond registered over the property and wishes to take another home loan (in the name of 3 parties), a new mortgage bond will have to be registered which would have costs associated.

      The couple wishing to purchase a portion of the property would need to purchase a share in the property, which has transfer duty costs associated. Once the parties have agreed on this purchase, the Title Deed can be endorsed in the Deeds Office to reflect the new names, and home loan finance can be obtained from the Bank for the loan required, provided that all parties qualify.

  • Hi Maya, have another property that I get rental income from and have the means to pay off the outstanding amount for the bond but I’m weary on going that route, especially regarding the tax implication I would not be able to claim back the interest payment on the bond. Have also been paying extra but had not informed the bank to allocate to the principal debt. To pay off the full loan and get an increased tax bill on rental or to allocate the extra payment over the years and ask the bank to reduce the monthly instalment?

  • Hi Maya I see that you say depending on your home loan agreement the bank would allocate the extra money to the priciple debt, under which circumstances or type of loan agreement would this not be the case.?

  • Good day, thank you very much for such stress saving input. I truly appreciate this. My question is i just realised my monthly installments increasing instead annually. what is the reason for this? as a would want a stanble monthly payment. secondly will paying that extra a month help to ensure i get fixed monthly installment? I am truly grateful for this advise

  • Ma’am

    I save to the tune of 30k a yr and I want to put this down on my bond every yr, does this means I will finish my bond earlier than the initial 20yrs?

    Lastly I’m contemplating of taking a lone and pay off my bond and pay the loan over a period of 5yrs which is quiet cheaper is that possible?

    Thanx

    • Any money you put into your bond will reduce the repayment period. It would make no sense to take out a loan to settle your mortgage as your mortgage would be at a much lower interest rate than the loan. Rather just pay extra into your mortgage

  • Let’s say you get paid on the 20th of every month but you put extra amount on the 1st of every month, would it also count or u have to put in extra amount on the same date the debit order goes through??

  • Do we need to go into the bank and arrange with them or does the bank automatically picks up the extra payment each month and directs it to the principal amount of debt cause I have been paying between a 500.00 to a 1000.00 extra each month and haven’t seen any adjustments to my statement or is it still early bound period now is about 8 years running

    • It should automatically go to the principle debt, but what I found with my bank was that as I paid in extra, they lowered the installment amount so it would still be paid off over the full period. I had to ask them to retain the original installment amount. I would suggest you ask the bank for the amortization statement – that will give you a better idea of the impact of those extra payments

  • According to me Home loans are a way to entrap people into unending debt. Don’t get a home loan unless you can pay 50% of the bond in cash. The best thing is to rent, but unfortunately there is a perception that renting a property is bad. People need to wisen up!

    • Based on calculations I have done, it takes about seven years for rent to catch up with the bond repayment. so if you are not planning on living there for more than at least five years, rental may be a better option

  • Hi Maya, if you pay in a lump sum like R200000 towards your home loan, will that reduce my interest on my home loan? How can I ensure that overall, I pay off my home loan quicker n with less interest?

    • I am tempted to cancel my investment portfolio (unit trust) and divert that monthly premium to the bond insted. The portfolio has been active for 5 years (investment term 15 years) and has literally been no positive gain since inception. It is frustrating to be charged all this monthly fees but 0 perfomance . I’m already paying R 2200 extra payment on R 6000 installment p/m bond at 10.75 % interest rate and the R 1100 monthly from the investment can make a massive impact in reducing loan term. Is it a wise decision to cancel investment? (Investment was just to save money)

      • You have been through one of the worst bear markets we have seen in a long time. But that is usually the time NOT to cash in. The markets have started to recover. I would suggest you also look at your investments to ensure you have a well-diversified portfolio

  • Very informative just got approved for a home loan on higher interest but due to my credit profile so they say. I appreciate the advice.

    Can I move my bond to other bank or negotiate lesser rate at the later stage?

  • I’ve been paying more on my loan for the longest time, yes first few years I’ve been difference, but later it was changing, not moving or even going up. I visited my bank several times and I was told is because of the insurance (25year money back guarantee) that I have signed, they can’t help me

    • The bank will immediately allocate that to the capital balance, so it reduces your outstanding amount. The only thing to check is whether they then reduce your monthly installment (as you have a lower balance). You want them to keep the normal installment so that you can pay off sooner

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