Keep Your Home Loan Payment Unchanged - To Pay Off Sooner
It was announced on 19 November 2020 that the national repo rate would remain unchanged at the historically low 3,5 % and the prime interest rate at 7% - which is the lowest it has been in 50 years.
While many were expecting an increase after a slightly strengthening economy, the unaffected rate is a welcome announcement to those repaying home loans. While this interest rate drop will result in lower monthly home loan repayments, it provides an excellent opportunity for home owners to get themselves out of debt sooner by leaving monthly repayments fixed.
- Utilize the benefits of compound interest
The primary benefit of a reduced repo rate lies in the ability to use the funds you would have used to pay off interest to rather cutting bite-sized chunks off the principal amount of the loan. Now those might be really small chunks you would be paying off, but when it comes to home loans, which work on compound interest, even a little goes a long way. Where simple interest is calculated on the principal balance alone, compound interest is calculated on the principal balance as well as the outstanding interest, meaning you're left paying interest on your interest.
When looking at the actual influence compound interest can have on the amount that will ultimately be paid back on a home loan, Albert Einstein's view makes a lot more sense: "Compound interest is the eighth wonder of the world."
Due to the nature of compound interest, it is always best to pay off a big chunk of the principal as soon as possible to reduce the amount that interest will be calculated on, which will also reduce the amount of interest that will be accrued over time. But even if you can only start paying back larger than required amounts later down the road, there are easy ways to increase your bond repayments:
- For those who are employed with businesses who were able to retain their financial strength throughout the lockdown, salary increases may still be a possibility. When a salary increase does occur, you could let the extra income you earn go towards higher bond repayments instead of finding other areas to spend the money in.
- While it is unlikely that the interest rate, which is already at a historical low, will be lowered any further, you could request that your repayment instalments are left unadjusted when the interest rate does drop again in the future (after it goes up again first), allowing you to pay more than you need to without it affecting your budget.
- You should ensure that a large portion of any bonuses or additional income go towards additional down payments over and above monthly instalments.
While the amount saved with new interest rates and the additional money you put towards increased instalments may seem rather small when compared to the full amount that will be paid against the property over the 20-year period, the key is to think of where else that money will be able to be invested. This should help you realise just how large the savings is rather quickly. Whether it will be used to pay off a study loan or used to help you avoid making a study loan in the first place, for example, the true value of the lowered repo rate only becomes obvious once you consider the effect it will have on your life outside of the property purchase.
So, while the repo rate is at a record low, it may actually be advisable to continue paying back what you were in 2019, or what you would have been paying had the economy been less turbulent in 2020. Doing this will allow you to save in the long run, instead of just grasping the saving opportunity that is in front of us right now. By resisting the temptation to lower your monthly repayments, you will reap the rewards of paying off your debts sooner and being able to channel the additional cash flow towards building sustainable wealth. Saving is habit-forming, and this interest rate cut provides an excellent opportunity for all home owners to establish disciplined saving habits.
Depending on how long you maintain the additional payments, doing this could significantly reduce the total interest you pay and shorten the loan repayment term.
To relay this into Rands:
If you would have a home loan of R1 million at an interest rate of 7,75% and a loan term of 20 years, your loan amount plus interest will be R1 970 275 with a monthly instalment of R8 209.
If you would pay an additional R1 000 per month, the loan amount plus interest will drop to R1 728 458 and your loan term would lessen to 15,67 years. That is a saving of R241 817 - making you 3,33 years sooner loan free.
- Access Facility
Remember to check if your home loan has an access facility - as it allows any additional contributions towards your home loan to remain accessible in the account and can be used if and when the need for emergency funds arises in the future. While an access bond is one of the best places to keep your savings, it can be the trickiest to commit to. This is because when we save, we expect to see our Rand balance grow as and when we earn interest each month. However, when saving in an access facility, the growth in your money comes from the interest you are not paying on your loan account. In other words, you will be in a better financial position by not paying 7% interest (prime interest rate) on your home loan than by earning interest of approximately 2.25% to about 5% in a savings account.