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How to halve your home loan term

Disciplined additional payments make a big difference.

In the same way the power of compound interest works to your advantage when saving over the long term, so it works against you in the largest purchase most people will make: their home loan. Over a 20-year period, the average home buyer will spend a significant amount of time – and a significant amount of money – paying back compounded interest.

While it is obvious that paying additional amounts into a bond monthly, no matter how little, will make a big difference over the loan term, most people don’t realise just how big an impact this can have.

Using the example of a R1 million home loan, with a monthly repayment of around R9 900 (including service fees), even an additional R1 000 a month will take almost a quarter (!) off the span of the loan.

Paying an additional R3 000 a month on a R1 million home loan will practically halve your term and, in so doing, save a total of more than R700 000 in interest and service fees! This is a LOT of money.

R1 million home loan at 10.25% (prime)

 

 

Extra R1 000

Extra R2 000

Extra R3 000

Monthly payment

R9 885

R10 885

R11 885

R12 885

Term

20 years

15 years, 4 months

12 years, 8 months

10 years, 10 months

Total interest

R1 355 944

R982 854

R782 801

R654 534

Total

R2 372 504

R1 995 550

R1 793 289

R1 663 505

Saved

0

R376 955

R579 215

R709 000

You might be rolling your eyes wondering where on earth you are expected to get an additional R3 000 a month from … that requires discipline and, crucially, not over-extending yourself when you buy a property.

A simple solution

In fact, buying a house that is 20% or 30% below what you can (or think you can) afford is possibly one of the most valuable financial decisions you could ever make.  

 

Source: Author

On a R2 million home loan, making a meaningful dent in the term (and saving a ton of interest) is a bigger ask – the numbers are larger! Minimum monthly repayments will be around R19 700, and an extra R1 000 a month is not going to make that big a dent. But R4 000 extra each month translates to a R1.1 million saving in interest and fees. The term won’t halve at this rate (it goes down to just under 13 years), but the total repaid is R3.6 million versus R4.7 million if you simply pay the minimum amount.

The calculations above are very simplistic, as they assume an almost robotic level of saving: a specific amount every single month. Life doesn’t work that way. Some months may be higher; others lower. It also doesn’t assume any adjustment for inflation, or account for changes in interest rates (which are likely).

What one should be doing – in an ideal world – is increasing your extra payments into a bond with inflation annually. In a benign interest-rate environment, this ought to be very easy. Your standard monthly repayment won’t change materially, effectively becoming ‘cheaper’ or more affordable over time. In just five years, a repayment of R9 800 a month will be the equivalent of around R7 500 in today’s money (assuming inflation of 5% a year). It should – in theory at least – become easier over time to find an additional R1 000 or R2 000 or R3 000 a month.

You will effectively be ‘saving’ into a home loan account, which has one advantage: you’re able to access the additional capital paid at any time. For undisciplined savers, this is an obvious disadvantage as the temptation might be there to dip into these ‘savings’ for ‘emergencies’. Treating these extra payments into a home loan as a one-way transfer (only into the account) is one way of maintaining the discipline.

Now, any additional payments into a bond shouldn’t (necessarily) be at the expense of other long-term savings, such as saving for retirement. That’s an entirely separate discussion, which requires input from a certified financial planner …

* Hilton Tarrant works at YFM. He can still be contacted at hilton@moneyweb.co.za.

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COMMENTS   13

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Much more useful to quote the total amounts saved in today’s real-terms – not adjusting them for inflation makes them about as useful as an insurer’s future value predictions.
Also consider that for a few the power of compound interest in savings (first paragraph) has not worked to their advantage – over 5 years in the local market after fees many are faced with the power of compounding real losses. Returns of about 5.8% on many funds less fees of about 1% against avg inflation of about 5.5%.

Alternatively, one can allow inflation over time to reduce the bond debt to half 😉

Huh Michael; really??

What a load of absolute 8347r&$@yh387y. Inflation does not reduce debt; your payments do. You get your payments from your income/salary. If you are one of the lucky few that get above inflation increases then great. Most do not.

The official inflation rate is in any event understated by about 50%.

That inflationary argument is a myth in functional terms. Ignore it.

Follow Hilton’s recommendations and pay off as quick as reasonably possible.

Don’t forget shrinkification 🙂

Pacaratac, no need for “panic-attac”, as there’s merit in both approaches.
One will typically read in 99% of articles to “pay your bond off quicker” to save interest. The default advice we read everywhere.
Mostly, examples are given where a few hundred thousand of interest can be saved over the term of a bond. And usually the remaining of term (for most people) on their bonds, are 10+ years still to go. People lose sight of the fact that the quoted “few hundred thousand” interest to be saved is NOT current value, as it is “future value”…and need to be discounted to “real terms / value today”.

Inflation skews everything. Like you, I previously also believed to pay off interest is the only advice one can give others.

Then (I admit, rather unconventional) articles crops up (there was one on MW as well last year…can’t find it), but read another one below:

https://www.thesimpledollar.com/how-does-inflation-affect-a-mortgage/

In essence, say if you have a R1million home loan in today’s terms….about 10yrs into the future that same R1mil home-loan debt may be say R500K in today’s terms (depending on annual inflation rate). That’s assuming your salary/pension has kept pace with inflation over the term, as say for example a R30,000 pm salary today, could likely buy you the same (in say 10yrs’ time) from a R60K per month income by then.
So if say a R60K monthly income (10 yrs into the future) is equal to R30,000 p.m. (in real terms) today, then it makes similar sense that a R1m bond debt in 10 yrs’ time, is about R500K worth in today’s value. The higher the annual inflation & the longer the term, the bigger the impact.

Also bear in mind, when one increases your bond payments (i.e. over and above what is required), the bank receives extra income stream from you IN REAL TERMS/TODAY’s VALUE….as opposed to you paying a higher bond for longer, but in reduced “future value” terms.

The other point where must of us will agree with, is that home-loan (or business) dept are considered “good” debt (as the asset increases in value, or the debt is used to generate business income higher than interest cost), versus “bad” type debt spent on DEPRECIATING assets (e.g. cars / furniture / clothing / and food, as worst example).

So, go back to your bank, and negotiate to re-open your access-bond. If you use the extra funds to invest in a sound business, good for you….if you use it to spend on car/holiday/consumer items…bad for you.

Off-topic, a further bonus is if one uses a property for income generation (e.g. working from home-office, or if property is outright used as a commercial/office/factory) where interest-costs can be pro-rata offset against income tax…then why settle debt faster? Business people use gearing in their favour…running a business using partially other people’s money.

Having said the above, I’m still an advocate for spending within your means, as SA in in a longterm upwards interest-rate cycle. Paying off debt faster or let inflation reduce the capital-value of debt, use either way to your advantage.

🙂

Exactly!

Sometimes people think perhaps like @pacaratac did, that you are just waiting for inflation to wipe out your debt and you are wasting and spending money like a mad man, but that’s not the case, when you really understand inflation, you will understand that it is a tax, inflation is a tax on savings, or as Milton Friedman put it : Inflation is taxation without representation.

Lets take Venezuela is a perfect example of this:

Lets all get into a time machine and go back to the year 2012 (a mere 7 years ago)

4-5 VEF would give you 1 USD.
Today its
251 000VEF to 1 USD.

In that time, interest rates have only moved from 16 to 22%.
So the currency has gone to the dumpster, and it didn’t even cost you a penny to repay your debt, if you had savings however, you where wiped out.

So the BEST, and there is no denying this, decision any Venezuelan could have made in 2012 was to make MASSIVE and I mean MASSIVE debt in Venezuelan Bolivars and buy : Land, Gold, off shore assets etc.

Everything that you bought with that debt, you almost got for free.

PJJ, I sort of get your point of view, however, please explain how getting into or remaining in debt would have been for your benefit?
The way I see it is you still owe that money and now, as in the case of Venezuela, you would still be earning VEF to pay off these loans.
The VEF you are now earning is worth nothing so please explain?
Cheers

@Narchie

I hope you still read this, moneyweb’s comment thing doesn’t give notifications, perhaps they should look at using Diqus? Anyway.

Its simple, like I said in my post you made your debt in VEF to buy any asset with intrinsic value like land / gold or even USD.

lets say you bought USD : at 6 VEF to USD back in 2012.
And you took out a 6M VEF loan to buy 1M USD

Now today you would have (not accounting interest) 1 USD worth of wealth from your VEF loan, your VEF loan has compounded at 22% interest since 2012 and now has a nominal value of 27.6M VEF

27.6M VEF today = 109.96 USD!!!!!

You take 109USD off your 1M USD account and you are left with 999890 USD of profit.

Jislaaik PJJ.

Well it is bleeding obvious that anyone paying off that bond debt early (a conservative bloke/gal) would be unlikely to go on another destructive spending spree; not guaranteed of course but unlikely.

Great theory in a runaway inflation style Venez. or Zim. Well fortunately that does not happen so much.

All this inflation theory, sorta assumes that you can keep your job, buy food, petrol and keep alive stuff and do in fact have an income of some sorts to pay off that now “small” debt.

While nice calcs, reality is that that RISK is a major component and blindly assuming that you have a job, can feed yourself and family till that wunderfool day of paying off with massively depreciated zimbucks is, well good luck to anyone who does that.

Regards

@pacaractac

“Great theory in a runaway inflation style Venez. or Zim. Well fortunately that does not happen so much.”

You don’t need run away inflation to take advantage of the monster that is inflation, its just the higher the inflation, the more the “debt relief” is.

Example : Argentina now has inflation rates of 47%
Let use 2012 again, the Argentine Peso was 4.5 to 1 USD.

Again lets make a 4.5M ARS loan to buy 1M USD.
Compounding at a annual interest rate of say 25% = 20.7M ARS today.

20,7M ARS today = 547 459.73 USD (37.8 ARS to 1 USD)
That is what your debt is worth in USD including all incurred interest, so you are left with 452 540.27USD worth of profit, like I said not nearly as amazing Venezuela but still VERY profitable and it didn’t require a Zim style meltdown.

Its this “debt relief” that inflation brings that government want/need the continue playing the game.

The only real comparison is what would you have had to earn on an investment on, say, the R3,000 that you pay extra to achieve the R700,000 saving. Without taking tax into consideration, it would be 10.25% or whatever the interest rate happens to be. So, the only comparable investment would be a tax free investment. But there you are limited w.r.t. annual investment and lifetime investment. The moment you bring tax into the equation, the required rate to equal putting extra money into your bond becomes even higher. The calculation can be done by this formula: (interest rate on debt÷(1-tax rate)), e.g. (10.25÷(1-0.3)) (30% tax within the product on a pure endowment policy). Therefore, you have to beat 14.64% consistently in an endowment to equal the extra payment on your bond. Patrick is right, each case has to be treated on its own merits because interest exemptions etc. also come into play. So, crunch the numbers or get someone knowledgeable to do so, but don’t just dismiss this option. It worked for me every time.

The problem is all these brokers out there selling retirement products to you when you are paying R 12,500 month in interest on JUST YOUR BOND!

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