Getting to grips with interest rates

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. But how does interest work?

STBB (Smith Tabata Buchanan Boyes) explains that it is calculated on the principal amount; If the bank / 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, explains Bruce Swain, CEO of Leapfrog Property Group.

• 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)”, advises Swain.

• Variable versus fixed

With the future of the South African economy in flux at the moment there is an excellent chance that the Reserve Bank’s Monetary Policy Committee will elect to raise interest rates over the coming months (especially if South Africa is downgraded to junk status), prompting many home owners 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 home owner would actually have been better off not fixing it”, explains Swain, “My advice would be to only fix your interest rate if you need to be certain of your cash flow”.

• Paying off your home loan faster

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

Pay in an extra R500 per month:

“Let’s use the example quoted above of a R1 million bond @ 10,5% over 20 years, with a monthly repayment of R9,897.20, equalling total repayments over 20 years is R2,375,328. If a homeowner pays in extra R500pm 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 of their property almost 3 years sooner”, explains Swain. 

Paying in an extra R1,000 per month:              

Swain explains that if the homeowner pays in an extra R1,000 pm i.e. R10,897-20, the total repayments over 20 years will be R1,988,739 (with total interest payable amounting to R988,739). Doing this will save the homeowner R386,589 and they’ll pay off their property almost 5 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”, believes Swain.