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Using your home loan to manage debt

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20 Mar 2013

Home loans can be useful tools for managing debt and are generally priced more competitively than short-term debt options - but how many of us really know how to use this facility effectively?

It is important for consumers to understand how to optimise their debt structures in order to create financial wellbeing, says Ewald Kellerman, head of sales at FNB Home Loans. Decisions on how a home loan is managed from the decision to move, upgrade or downgrade your home, to the structure of monthly repayments and deposits, could significantly affect the amount of interest charged and the overall benefit you will derive from this credit class, he explains.

It is important for consumers to understand how to optimise their debt structures in order to create financial wellbeing, says Ewald Kellerman, head of sales at FNB Home Loans. Decisions on how a home loan is managed from the decision to move, upgrade or downgrade your home, to the structure of monthly repayments and deposits, could significantly affect the amount of interest charged and the overall benefit you will derive from this credit class, he explains.

Most of us probably know it's a 'good idea' to pay more into our home loans each month and by doing so we will save on interest. But how many really practise this? Let's face it, we live in a consumer driven world where we are constantly bombarded by images and messages of what we could or should have in our lives. It's easy to feel that you 'need' a new car or deserve an overseas trip because others around you seem to be indulging, and while you don't have the cash now, you believe you can 'cut back' later and 'so what' if you pay some extra interest. We're human after all, and at some stage most of us except those truly disciplined individuals, will spend on something that we know we shouldn't buy with money we don't have.

Add to this the ever increasing cost of living, slower salary increases, risk of retrenchment and those unexpected costs like your child needing to go on a school sports tour or a water pipe bursting that requires instant attention and your money. For those times where you have a genuine emergency, a home loan facility with prepaid funds can be a lifesaver.

That's one good reason why you should pay in more than your instalment amount each month, to create a facility that gives you cash flow when you need it most. And if you plan ahead and decide to use prepaid funds to finance a new car or a holiday for the family, saving extra into your bond each month makes a lot of sense. Just remember though, not to pay your car off over 20 years, so plan ahead and be sure you understand the cost implications.

At the start of a typical 20 year bond agreement, progress can seem slow and you may feel there is little ''visible benefit" to paying in extra amounts in terms of the reduction in the total outstanding. However, Kellerman says small changes in the way a home loan is managed can make a significant difference down the line.

Consumers do not always realise the power that a home loan holds and may often be discouraged by the relative long-term payment period, he says.

Tips for using your home loan more effectively

A home loan is not only a means to buy property, but can be a useful way to manage debt or an interest savings mechanism that stretches far beyond the initial property transaction, says Kellerman.

He explains that a typical home loan's interest is calculated daily and capitalised monthly, which means that daily fluctuations in balances changes the amount of interest being added to the loan, and can incentivise the borrower to pay additional funds into the account as early as possible. "This is in contrast to an instalment sale loan where interest is often capitalised upfront, and a fixed amount paid off over a term."

Flexibond facilities or their respective counterparts at other banks allow easy access to your home loan, he says, allowing access to any prepaid or surplus funds that have been deposited above the required instalment.

Home loans typically offer cheaper interest rates than other short-term debt and the interest rate is linked to the borrower risk, which is reduced by the security of the immovable property. However, Kellerman notes that the interest rate on borrowed funds remains higher than typical investments i.e. bank deposits.

Given the way that interest is calculated, the transactional capability and the typical rate charged on a home loan, Kellerman says home loans are ideal for:

  • Interest savings - these are tax free whereas other savings might attract interest  that may be taxed and savings will perform better than a separate savings deposit that attracts a lower rate of interest.
  • Debt consolidation - can be used to settle other debt. Increasing the value of your bond to pay off other debt could significantly reduce the total amount of interest paid on all debt. Short-term or revolving credit such as personal loans, credit and store cards attract higher interest rates in line with the risk faced with these lines of credit. Tapping the equity in your home loan to repay these debts could significantly reduce the overall rate of interest charged.
  • Funding other purchases - where there is enough equity in a bond to buy a car with the surplus, the rate of interest charged could be significantly reduced by funding the purchase via the home loan instead of another line of credit. Similarly, other lifestyle expenditure such as holidays can be funded from the home loan account instead of through the often more costly short-term debt.

While home loans are a useful debt instrument, it would not be wise to use the facility to go on a spending spree and becoming financially savvy should always be the overall goal. Deciding to pay more into your home loan each month is definitely a wise move and will reduce not only the interest paid but also the period of payment.

Kellerman says if a homeowner with a bond of R1 million pays an additional 10% over and above their instalment each month, they could save up to R250 400 and reduce the time by 4 years (assuming an 8.5% interest rate). "The additional repayment is immediately set off against the capital value of the loan, thereby reducing interest paid."

Similarly, a R100 000 deposit (10%) upfront saves approximately R452 000 in interest payments and reduces the term by 4 years and 3 months. He says the effect becomes even more pronounced on interest rates as they go up.

Current low interest rates offer the ideal opportunity to repay a home loan ahead of schedule, says Kellerman, and according to the FNB Home Loans Quarterly Report 2013, there has been an increase of prepaid accounts among the bank's home loan clients from 12.2% in mid 2008 to 20% at the end of 2012.

The report notes that it is not just prepayment that has shown a positive trend, but also decision making when planning to hold on to a property. The average time bonds are being held before being cancelled increased by 8 months and 13 months for sectional and full title properties respectively.

Residential mortgages still account for the largest percentage of household debt, representing 58%.  The household sector debt to disposable income ratio showed a gradual decline from an all time high of 82.7% in 2008 to 75% at the end of 2011, rising mildly in 2012 and ending the year slightly higher at 75.8%. Kellerman says this indicates there is still much work to be done in lowering consumer debt levels, which funded the property and consumer boom in the earlier part of the last decade.  

While low interest rates have offered the opportunity to reduce debt, he notes that consumers tend to be "pro-cyclical" in their spending and borrowing, and generally borrow more when interest rates are low instead of using this to reduce debt. Hence, the resumption of uptake of new credit with overall non-mortgage credit to households growing by a massive 23.3% year-on-year as at December 2012.

Kellerman says other trends noted are the considerable decline in popularity of further loans and switching banks for accessing equity. However, he says despite the decline in popularity, a home loan is still arguably the cheapest, most flexible way of borrowing money. - Julia Hinton 

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