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Thursday, 22 November 2012

The benefit of paying that little extra into your homeloan


Why you should be spending your 13th cheque to pay it off.

It’s been a long, tough year and as the festive season approaches, one might be tempted to think that loosening your purse strings over this period may be the best way to reward yourself for surviving the challenges of 2012.
A different approach however, would be far more rewarding and is the best gift you could give yourself.
South African homeowners have been under financial strain over the past few years, as is evident in the sticky high debt to income ratio.
In this context, the December period is a good time to start putting in place a financial plan for 2013, rather than spending money now for short-term feel-good moments, which can place you under pressure in the New Year.
For those receiving bonuses or 13th cheques in December, some of the extra money should be used to reduce your debt, particularly large commitments such as home loans. This principle is particularly important when it comes to home loans as a mortgage is probably the single biggest debt the average person will incur, and it stretches over decades.
Even a few hundred rand a month extra paid into your home loan can bring down the interest burden and the term of the loan significantly, and save you hundreds of rands in the long term. You end up with less of a financial burden at the end of every month.
“Payment holidays” that some see as an option for extra cash at this time of the year is not a good financial decision. Remember that a monthly payment is required on your home loan. Taking a holiday from your payment will not benefit you in the long run, as it will cost you more over the long term.
But what about having some fun during the holidays?
Fun with a plan is the best option as this keeps you responsible and ensures that the fun is not short-lived with negative long-term effects. The challenge of the summer holidays is that most people get paid earlier than usual in December and this makes managing your money until the end of January a challenge. Most of us are used to managing through about four weeks, not six or seven.
In addition, a bonus or 13th cheque provides a false sense of increased earnings which makes us feel that we can spend a bit more without necessarily watching the budget.
The problem, of course, is that your month-end payment commitments for December are still there. And January has more expenses than most other months, because of school fees, stationary and uniforms, and too often, we also have a financial hangover to cope with from spending more than we should have in December.
Planning ahead can help avoid spending the rest of 2013 trying to recover from a few moments of madness in December.
What does paying a little extra into your home loan get you?
Paying a little extra into your home loan on a monthly basis or one off, can save you hundreds of thousands of rands in interest and will reduce your bond term. Below is a table demonstrating the benefits of paying extra into your home loan using an example.
Graph: Prepayment loan curve vs Normal loan curve
The difference between paying R1.1M for a R700 000 loan or R1.5M (Interest cost + capital)
The above graph shows the benefit of paying extra money into a home loan. The example used is a loan taken in April 2008 for R700 000 at an interest rate of 15% per annum, over 240 months (20 years).
The blue line represents the customer who chooses to keep payment at the same instalment level of R9217.53 each month, despite reductions in the interest rate over this period. The bond term reduces by 10.5 years (assuming that the lending rate remains at 8.5% from July 2012 until October 2018).
The red line represents a customer who paid the minimum monthly instalment only over the 20-year term (assumes that the rate remains at 8.5% from July 2012 until April 2028).

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