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.

59 CommentsLeave a comment

  • Hi Maya,

    thank you, great advice as always.
    We have a flexi bond account, meaning the installment changes as interest rates changes. what i find confusing is that everytime we put in extra into the bond then the following month our bond installment is also reduced , why do the bank do that ? how can i get them to fix my installment to the linked interest rate and not change everytime we put in extra in the bond because i feel like they are countering our efforts to reduce the debt and pay it off earlier..
    Thank you

  • Hi,

    I have been paying extra into my bond and it just reduces the outstanding balance. Is there any benefit to having the extra funds that have been paid in capitalized? I thought that by capitalising this money i could ask for it to be allocated directly to reduce the prinicipal amount but the bank says this is not possible as it will only reduce the outstanding balance

    • Not sure what you mean by principle amount, but when you pay extra into your bond it reduces your outstanding balance (the capital amount you owe) which means that the amount of interest you pay reduces. It will be difficult to see the impact at the moment as interest rates have been decreasing, but if you compare your interest charge on your statement you will see that the interest charged has been decreasing as you add in extra funds. This means more of your installment goes to reducing the outstanding loan and so your repayment period reduces. Just make sure your minimum monthly installment is not reduced by the bank as your outstanding balance is reduced.

  • Thank you Maya! Its amazing how little advice our banks “lend” when we borrow such substantial sums. Your R500 extra grid is on point and ppl must have it debited automatically from day one – you don’t miss that R500 bucks anyway!
    Heres my story, I have R20K left to pay but I want to keep my bond account open indefinitely. I want to borrow money at MY BOND RATE for future needs; paying my son’s monthly university fees etc. Is this a good strategy or must I make arrangements to collect my title deeds?
    Thank you!
    Ronny

    • Your home loan is a great, low cost credit facility. Just keep in mind it costs around R60 a month to keep the facility open, but worth having the access. Just make sure you maintain discipline and that you enter retirement with no mortgage debt

    • This is the amount of interest you will still pay over the period of the home loan. You will not necessarily pay that interest if for example the interest rate changes or you pay off the home loan sooner. They can only capitalise interest for the current period.

      “Uncapitalized interest would be the future interest to be earned by the lender on a loan. Given that interest is the lender’s compensation for lending the loan, the lender can only capitalize the interest to the outstanding balance relating to the period of the loan that has elapsed”.

  • When the recent rate change occurred the system automatically recalculated the required instalment due based on outstanding balance + available prepaid funds over the remining loan term to ensure the bond amortizes correctly over remaining loan term…….This is the answer I got from the bank when I needed to know why my current monthly payment on the outstanding balance of R500287 is still same as the initial amount of R573000.( having +- 71000 in prepaid funds)

    I might not know much on amortisation, Maya can you please explain it in a laymen’s language?

    • I would need to speak to the bank to get a better understanding but what may have happened is that when you put in the prepaid funds, the installment reduced. Over time that results in effectively “eating” into the pre-paid funds. Have you noticed prior to the interest rate cuts that your installments decreased when you add in extra funds?

  • HI,

    I have signed up for a 1 million rand bond for the next 20 years. I do have a lump sum of cash I would like to pay in.

    How do I pay in this money? Do I just ask the bank to allocate the money to the principal debt? I also want to monthly instalment to be re- adjusted and will continue to pay in extra each month, is this something I need to ask them to do or will it re-adjust automatically?

    Thanks

    • You can just add the money into the bond account, but you must inform them NOT to decrease the bond installment as a result – otherwise you lose the benefit of paying in that lump sum. You can ask the bank to deduct a set installment each month which is higher than your bond repayment

  • HI Maya. I have recently taken a hoam loan of R900000 for a 25 year term. I started saving an extra R2000 in my bank account every month to oay towards the loan. However, i haven’t sent these extra payments to the bank because I am not sure how best to reduce my capital? Like should it be through lunp sums? Or is there a particular time in the month where the monthly additional payment will have the most impact?

  • Hi Maya

    Great article. I have one question. I took out a home loan in 2014 for 790000 payment of 8500 at 10.5% interest rate, now in 2020 the interest rate has dropped to 7.25%? and I still own 688000. Is it better to put in additional monthly payments when the interest rate is high or low? I understand I will reduce the term of the loan and payments but do I save more when the rate is lower or higher if I had to make additional payments per month?

    Regards
    David

    • When interest rates are lower your debt is costing you less money, but it also gives you the perfect opportunity to pay off your property sooner. Money that was going to interest can now be allocated to capital. By continuing to pay R8500 a month, even though your monthly installment has dropped, you effectively pay in extra to your capital each month. Also keep in mind that these low rates are expected to be short-lived. Once the economy recovers and inflation returns, rates are likely to rise. So by keeping your installments at the original level, you know you can absorb additional rate hikes in the future without affecting your budget.

  • Hi Maya, I hope this finds you well. I do not know much about home loans and their repayments, including interest. What I’ve seen so far when looking at listings and loan repayments is that one ends up paying almost if not double the value of the house at the end of the mortgage, which means the interest is just about the same amount as the purchase price of the house. My question is, is it in any way possible that one can secure a personal loan of the price of a house and pay back that loan, or would the repayments of the personal loan be the same as those of a home loan (i.e the final amount paid back on the loan)??

    For example, if I get a home loan for R600K and end up paying back R1.3m after 20 years. Would I end up paying around the same R1.3m for a personal loan of the same amount??

    I’m only 25 and still in school by the way, but this home loans and total amount in repayment… especially the interest kind of worries me a bit.

    Thank you. ?

    • I am glad you asked the question because it is something a lot of people do not realize and a topic I covered in a podcast //mayaonmoney.co.za/2019/09/listen-the-20-year-home-loan-fallacy/
      The reason the total interest is so high is because of the TERM of the loan being 20 years. A personal loan may be only five or ten years. However, you can take out a home loan of only five years and save a huge amount on interest. Home loan interest rates are lower than personal loans so it makes sense to rather take the home loan and pay if off over a shorter period.

  • Hi Thanks for the article. I have a question, if for example, you take a home loan for 30 years of R1m. And after paying for a few months, you sell the property for R1.2m. If i pay this R1.2m to the bank, will I be relieved of the debt or will I still need to pay the interest for the 30 years? How does this work and with the interest when you pay off your property before the repayment term ends?

    • You will never pay for interest you have not incurred. The bank simply gives you the quote on the interest so you understand the full implications. If you have met your repayments each month there should not be any outstanding interest. Keep in mind you must give your bank 3 months notice that you are closing the bond otherwise they will charge you a penalty of three months interest.

  • Hi Maya
    I have a property since 2007 and will now enter year 13. Currently this property is on my and my ex wife’s names. I have to transfer the property to my name and if I understand correctly I have to basically apply for a new bond. I will not get the same interest rates I got 12 years ago. What are my options to transfer the property and to keep the cost as low as possible?
    Thank you

  • Hi
    I and my wife have applied for a home loan and got 80% with APPROVAL IN PRINCIPLE over 20 years. I would like to convince the bank to give us 100% over 30years rather. Is that possible?

  • 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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