Paying my home loan early - penalties?

31 Oct 2012

A Property24 reader asks:

A reader asks if she can settle her home loan before the 20-year term but keep the facility open and how to avoid any penalties..

We intend to settle our home loan shortly but I need some advice in order to avoid penalties. Can we settle the major part of the amount owed and leave a minimal amount like R500 in our bond until the 20-year term expires?

Gustav Zwiegelaar, Regional Manager at SA Home Loans in the Western Cape, advises:

When an outstanding loan amount is settled in full prior to the contractually agreed to date, some financial institutions apply interest that would have accrued against the outstanding amount for a certain period, usually 90 days, as part of the settlement figure.

It is important to understand the difference between a bond that is registered in the Deeds Office and the actual financial loan that it is registered for.

A bond is registered in the Deeds Office as a legal vehicle to allow for borrowing against something of value, in most cases immovable property.

The explanation that I use most often is that a bond is like a suitcase that allows you to carry the finance. Let us use an example of a bond registered for R1 million.

You may purchase a property for R800 000 and take a loan of R800 000. A bond of R1 million may be registered in the Deeds Office and will legally allow a financial institution to grant a loan of up to R1 million against it.

The suitcase, or bond, has capacity to carry R1 million in cash as a loan. It does not follow that the suitcase must be filled. It is merely a legal facility for a loan of up to R1 million.

In our example, the value of the property is R800 000 and a financial institution is likely to give a loan of up to R800 000 as at present value. The R200 000 capacity is legally there but can only be used once the property has escalated in value sufficiently to allow for a loan to be offset against the value thereof.

To answer your question. Let us assume that you have a bond registered in the Deeds Office for R1 million on a property and take a loan of R800 000 against it. If you choose to rapidly repay the loan, the balance of R800 000 will decrease but the legal facility will remain at R1 million, allowing you to re apply for a loan against the registered bond in future.

As the balance of your R800 000 loan decreases, so does the interest charged against it. A very simplistic calculation of monthly interest is as follows: Amount outstanding x interest rate = annual interest / 12.

From this calculation it is clear that any monies paid over and above the agreed instalment will reduce capital outstanding. Thus, paying a lump sum into the loan account would result in interest being calculated on the reduced balance.

It follows that settlement of the loan amount would render the amount that interest can be calculated against as zero. Financial institutions extend finance in anticipation of earning interest on the outstanding balance and early settlement charges are not uncommon, mostly equal to 90 days interest on the outstanding balance prior to settlement.

The early settlement interest is normally calculated and applied as part of a bond cancellation process where, typically, a property is sold. If monies are paid into a bond but the bond is not cancelled there will thus not be an automatic requirement for penalty interest and the bond will simply remain open with a small or zero balance.

The question specifically relates to early settlement of a loan but not closing the bond. This is possible and should not result in any penalties as the bond remains registered and therefore your “suitcase” is still intact, ready to fill with a loan if and when you need to.

In our example you may have registered R1 million and reduced the initial R800 000 balance to R500. As there may be sufficient value in the property after some time has passed a loan of R1 million can be raised against the bond. This could be used to refinance additional property or renovations. In this way the initial registered bond may be used as a vehicle to finance capital intensive expense. As long as it is managed wisely and not used frivolously it can be an effective tool to assist in wealth creation and asset growth and does not need to carry financial penalties.

Readers may submit questions to Property24’s Guest Expert panel and/or comment below. We may not be able to answer all questions received, but all will be considered. 

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