If you are confused about the effects of depositing extra funds into your home loan, you are not alone. During lockdown, many people looked into their finance agreements, which resulted in a lot of queries about what happens when you pay an additional amount into a home loan.
For most people, their home loan is structured as an access bond, which means when you pay in extra money, it reduces the interest you pay on your mortgage but also leaves funds available for you to withdraw. Some families use this facility to save up to pay their annual school fees as a lump sum, for example, but for many people, they just want to pay in extra to settle their home loan sooner.
Many people are unclear as to how amortisation works and how these additional payments are used to reduce their home loan. It is important to understand how your mortgage provider treats additional payments.
Lower monthly instalment
In the case where your additional contributions, or prepaid funds, result in a reduction of your monthly bond instalment, the period of the loan remains the same. In order to ensure that the outstanding balance as well as the funds available for withdrawal are both zero at the end of the term, the prepaid funds will reduce by the capital portion not covered by the lower instalment being paid. You will still be able to withdraw available funds, but they will reduce over time as you are taking this benefit in a lower monthly instalment.
Monthly instalment remains the same
In the case where your additional contributions or prepaid funds do not reduce the monthly bond instalment, which remains the same as the initial agreement, you will pay off the loan sooner if you do not access those additional funds.
Any pre-payment is automatically used to reduce the outstanding balance of your home loan and you only pay interest on the money you owe the bank. This means that the percentage of your instalment that goes to interest is lower so the amount going to repay the capital is higher.
For example, if you had a home loan of R1 million with a 7% interest rate, you would pay around R7 800 as a minimum instalment to ensure it is paid off within 20 years.
If you put in a lump sum pre-payment of R200 000, you reduce the outstanding balance to R800 000 and you only pay interest on R800 000. That means the interest portion of your instalment drops from R5 800 to R4 700.
Prior to the advance payment, R5 800 of your R7 800 instalment was going to interest and only R2 000 to capital. Due to the R200 000 pre-payment, only R4 700 is now going to interest so that means R3 100 is going to capital. With more of the instalment going to capital, you pay off your home loan sooner.
However, if you needed to access that R200 000, you could withdraw it, but it would then increase your outstanding balance and the interest portion of your instalment would increase whilst the capital repayment amount deceases.
Think of a credit card or store card. You have an outstanding balance (money you have spent) and available balance (credit available). You only pay interest on the outstanding balance not the total credit available.
What has created confusion is that the credit available on your home loan reduces in line with the amortisation curve so that on a 20-year home loan, in month 241 the credit limit reaches zero.
Basically, credit you use will have to be paid off in the number of months left on the term of the loan. This is calculated based on your minimum instalment as per your home loan agreement.
Can I ask the bank to capitalise my additional funds and reduce my home loan?
Mfundo Mabaso, head of home finance at FNB says at any point you can ask the bank to reduce the available credit on your home loan facility. You keep the original instalment and ask them to shorten the period of the home loan.
It is important to note that there is no financial benefit to doing this other than providing discipline to not access those available funds in the future. If you did not ask for the home loan facility to be reduced, but never drew down on the additional funds, you would still pay off your home loan over the same period as if you asked them to shorten it. It is the same net effect.
If I pay off my home loan sooner, can I keep my access bond?
If you simply leave the additional funds in your home loan account, once you reached a point where the advance payments equal the outstanding home loan, you would not be charged any more interest and you would no longer pay an instalment other than the monthly service fee of R69. Think of this as having used additional payments to settle your mortgage but that you have a credit facility with your home as security.
Using the example of the amortisation curve on a R1 million mortgage over 20 years, in month 142 (nearly 12 years) your outstanding mortgage is R600 000. You get a surprise windfall which you use to pay in R600 000 and effectively settle the bond. You could either at this point make the home loan facility paid up and remove the mortgage over your property or you could leave the home loan facility as a credit facility. You will only pay interest on this facility if you draw down from it.
As Steven Barker, head of lending at Standard Bank explains, you still have a credit agreement (home loan) which gives you access to credit of R600 000, but that reduces each month according to the amortisation curve. So, in month 213 your credit facility has reduced to R206 000 and by month 241 it is zero.
Barker says the reason the banks do this is because they don’t want someone one month before the home loan contract ends suddenly accessing the original home loan amount as credit because they would have to fully settle it the following month (although some banks like Investec do allow for this).
Note that it does not make sense to put more money into your access bond than you owe on it as you do not earn additional interest on this. If you have reached this point, rather put the extra money into an interest-bearing account.
If I have paid additional funds into my bond, can I access the full amount?
This depends on how your specific facility works. If the bank has reduced your instalments, then your available funds will reduce each month. If you maintain your original instalments, then the pre-paid funds remain available.
What is amortisation?
An amortisation schedule is a complete table of periodic loan payments, showing the amount of capital and the amount of interest that each payment is made up of, until the loan is paid off. Each payment is the same amount in total for each period. However, early in the schedule, the majority of each payment is what is owed in interest; later in the schedule, the majority of each payment covers the loan’s principal. In an amortisation schedule, the percentage of each payment that goes toward interest diminishes a bit with each payment and the percentage that goes toward principal increases. Investopedia.com
Note: Only after ten years (120 months) is the interest portion of the instalment lower than the capital portion.
Overview of banks’ access bond offerings
Speak to your bank to ensure you understand exactly how the access bond works and what funds remain available.
FlexiReserve allows customers to access funds that they have already paid over and above the minimum monthly payment on their home loan, i.e. additional funds that are over and above the minimum required monthly payment on their loan. Additional funds paid in will not automatically lower your monthly repayment, unless you capitalise the extra amount paid in advance and ask the bank to recalculate your repayment.
FNB’s Flexi Option provides the ability to deposit surplus funds and further allows electronic access to these funds 24 hours a day. Monthly instalments remain the same throughout the term of the loan so surplus deposits remain available.
The NedRevolve facility on the Nedbank home loan enables clients to access any surplus funds that accumulate over time when they pay more than the minimum instalment or a lump sum into their home loan account. Any additional funds deposited can be withdrawn whenever the customer needs them. The monthly instalment does adjust and is recalculated monthly where additional funds have been paid in.
Access Bond link option 1: The instalment will not reduce when funds are prepaid into the account but will result in the loan being paid off quicker if additional funds are not accessed, saving the customer interest. You are able to access all your pre-paid funds.
Access Bond link option 2: The instalment will reduce when funds are prepaid into the account, resulting in the term of the loan remaining the same. You will still be able to withdraw available funds but they will reduce over time as you are taking this benefit in a lower monthly instalment.
This article first appeared in City Press.