01 Feb 2013
Although in January the Reserve Bank Monetary Policy Committee left rates unchanged, the reduction in the prime lending rate of 50 basis points from last year will, for many people, translate into a lower monthly instalment on their home loans.
However, keeping your instalment at the same level as prior to the cut can result in significant saving over the long-term.
Let’s take an example of a home loan of R700 000 over a 20 year term.
With the current low interest rate and coupled with the rate cut from last year, this means your monthly instalment would reduce by around R223 per month.
If you continued paying this R223 per month into your home loan facility – effectively keeping your repayment at the same level – you would save yourself R72 435 in interest over a 20 year term.
You would also repay your loan over a shorter period.
In fact, if the instalment repayment amount had been kept at the same level as five years previously, a customer could have repaid their loan in just over 10 years, instead of 20.
If a customer had taken a home loan of R700 000 in 2008 over 20 years, at a 15 percent interest rate, the monthly instalment would have been R9 218.
In 2012, with an 8.5 percent interest rate, the instalment would have reduced to R6 201 but if the customer had continued paying the instalment of R9 218, their repayment term would have been effectively halved, and they would have saved close to R400 000 in interest payments.
On a loan of R500 000, also over a 20 year period, the reduction on the monthly installment would be around R160 as a result of the 50 basis point reduction.
If the installment was not reduced by this amount, the interest saved would be R38 283 over the term.
To take this a step further, if we assume an interest rate of 8.5 percent, paying an extra R500 above the required monthly instalment on a R500 000 home loan can save a customer R136 473 in interest - and reduce the loan period to fifteen and a half years.
Instead of seeing the few extra hundred rands that become available as a result of a lower monthly instalment as ‘free money’ for consumption, consumers can be putting the money to hard work as the end benefits can be significant.
Paying extra money into a home loan, over and above the required monthly instalment, reduces the original loan amount, known as the capital debt.
As interest is calculated on the daily outstanding balance on the loan, a reduction in the capital debt reduces the interest calculation on your loan.
The more you pay into your home loan, the quicker you reduce the capital loan amount, and this can end up saving you thousands of rands in interest.
Interest rates are at their lowest levels in 35 years, and it’s uncertain when in the future rates will rise again and paying a little extra money into a home loan now will also provide a cushion when rates do eventually start to increase.
By reducing your home loan balance now, you reduce the impact of rate hikes in the future, as your outstanding balance on your home loan will be lower when rates increase.
Why do banks reduce my instalment?
Banks are required to amend the variable interest rate when the repo and prime rates change.
When the rate on a loan is changed (increases or decreases), the monthly repayment on the loan will automatically recalculate to ensure that your loan is repaid over the agreed term.
You can ask your bank to fix your monthly repayment at your previous instalment, or at higher amount than the required instalment, and save in the long-term.- Steven Barker
Steven BarkerSteven Barker is the head of Home Loans at Standard Bank South Africa.
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