What you need to know: interest rates and your home loan

Buying a home is likely the largest financial decision most people will ever make.

Not only do buyers need to save up for a deposit, but they also need to calculate their monthly repayments - including interest - when deciding to buy, says Bruce Swain, CEO of Leapfrog Property Group.

But how does interest work?

According to Smith Tabata Buchanan Boyes (STBB), it is calculated on the principal amount: If the bank or the mortgage lender advances a buyer R1 000 at 10% per annum, it will earn 10% interest after 12 months, and in the next year, the same amount. By the same token, if you are the borrower, you will pay R100 interest in the first year, and a further R100 interest in the next year.

“For a practical real estate example, take a property with an asking price of R1 million, bond at 10.5% interest over 20 years. The monthly repayment will be R9 897.20, with a total repayment of R2 375 328 - and total interest repayment of R1 375 328 - over twenty years,” says Swain.

Swain discusses home loan interest rates:

1. How to get the best rate

Naturally, the first best thing to do is to negotiate a low interest rate when purchasing a property.

“An expert mortgage originator can do a lot to help buyers get a good rate, but offering to put down a larger deposit can also make a significant difference in the rates offered as the risk to the bank has been lowered,” says Swain.

2. Variable versus fixed

With the future of the South African economy in flux at the moment, Swain says there is an excellent chance that the Reserve Bank’s Monetary Policy Committee will elect to raise interest rates over the coming months, prompting many homeowners to consider fixing their rates.

“Fixing your interest rate on your home loan does provide additional security during uncertain times, allowing for greater cash flow certainty, however, if the interest rate drops during that period, the homeowner would actually have been better off not fixing it,” says Swain.

“My advice would be to only fix your interest rate if you need to be certain of your cash flow.”

3. Paying off your home loan faster

Regardless of income, Swain says it’s in everyone’s interest to pay off their home loan as soon as possible as it will save a lot of funds in terms of interest repayments, as well as securing a debt-free asset.

Paying in an extra R500 per month:

 “Let’s use the example quoted above of a R1 million bond at 10.5% over 20 years with a monthly repayment of R9 897.20 equalling total repayments of R2 375 328 over 20 years,” says Swain.

If a homeowner pays in extra R500 per month into their bond, i.e. R10 397.20, their total repayment over 20 years will go down to R2 144 942.36, with a total interest repayment of R1 144 942.

“The homeowner will save R240 386 and pay off their property almost three years sooner,” says Swain.

Paying in an extra R1 000 per month:              

Swain says that if the homeowner pays in an extra R1 000 per month, i.e. R10 897.20, the total repayments over 20 years will be R1 988 739, with total interest payable amounting to R988 739.

He says doing this will save the homeowner R386 589, and they’ll pay off their property almost five years sooner.

“It makes sense to pay off a property as soon as possible, not just in terms of the interest saved, but also in terms of being able to use that property to generate more income by getting a loan for further studies, investing in more property and the like,” says Swain.