Portia Letlape: Head of Product at Absa Home Loans, explains how any extra money you may earn, such as bonuses or income from other sources, can be used effectively to reduce the term of your home loan or allow you some financial peace of mind in an emergency.
Q: What are the benefits of paying more into a home loan account?
Paying more than your minimum monthly instalment on your home loan lowers the principal debt owed and the interest you are paying, which is calculated on your outstanding balance on a daily basis. If you make regular pre-payments into your home loan account, you will be able to settle your home loan sooner than the agreed contract period.
There is also an added benefit of building up a rainy day fund, whereby any unforeseen emergencies can be catered for should you have a facility linked to your home loan account allowing you to withdraw any pre-payments made into your home loan account. With at least six-month’s worth of living expenses available in the home loan, you have the financial reserves available to you when you most need financial breathing room. The excess could also be used as a form of savings towards a holiday, a child’s university fees, or even a renovation project. It’s a flexible system that ultimately works to a homeowner’s advantage.
Q: What percentage of extra payments go towards interest and percentage towards the actual loan?
There is no fixed percentage that is applied to interest and the actual loan in the repayment amount. Interest is charged on the outstanding balance of the loan. At the beginning of the loan, the interest portion will be greater than the capital (actual loan) repayment portion because the outstanding balance is high, but as the loan term progresses and the outstanding balance reduces, the interest portion in the repayment will also reduce, and a bigger portion of the instalment is applied to reduce the capital. The effect is that the outstanding balance will reduce faster as well as the interest.
If any amount in excess of the minimum instalment is paid into the loan account, the excess amount is applied directly to the outstanding balance, thus reducing the interest calculated on the outstanding balance. This has the effect of a reduction of the loan term.
Q: Can you specify that the extra payment goes specifically towards the interest only?
No. Any additional funds paid into the account are directly applied to the outstanding balance. Keep in mind that this is only applicable on accounts that are paid up to date. Loans in default function differently, i.e. we will apply the funds against unpaid interest before the capital amount.
Q: Some use the excess as a way to fund other projects/purchases. How do these fluctuations impact the home loan?
Most banks allow customers to withdraw prepaid amounts from their home loan, should they wish to do so. These amounts are subject to the bank’s discretion on how much of these prepaid amounts can be made available to you. Remember, interest is calculated daily on the customer’s outstanding balance at the agreed interest rate.
Here is an example:
If you had an outstanding balance of R800 000 and paid an extra R100 000 into your home loan, your outstanding balance would be reduced to R700 000. The bank would accordingly calculate interest payable on R700 000.
The prepaid R100 000 will be made available to you (subject to the bank’s calculations) but should you withdraw the R100 000, your outstanding balance will increase to R800 000, and the interest calculated on the higher outstanding balance.
Should you not wish to access the prepaid amounts, you can request that the bank capitalises any prepaid amounts. This means that the extra amount you have paid in would no longer be accessible to you in future but will reduce the monthly instalments due. In this case, your loan term will remain the same as the contractual term.
Should you still wish, after such a readjustment, to pay off your home loan sooner, you could consider fixing your home loan debit order amount to be higher than is required. This again means you will be able to continue saving on daily interest charges.
Q: Does paying more influence the credit rating of the individual, and if so, how?
Paying more on your home loan is not reported to credit bureaux, whereas any missed payments and late payments are. The banks are, however, required to report any outstanding loan amount. In the example we used above, where the customer prepaid R100 000 on a loan with R800 000, the bank would report an outstanding balance of R700 000.
Q: If you've paid extra, can you skip monthly instalments?
No, paying monthly instalments towards your home loan is a contractual agreement between you and the bank. Failure to make a monthly repayment will result in you being in default of your agreement and may affect your credit rating with the credit bureau.
Q: If you do pay off your home loan early - no bond at all - what are the consequences in terms of bank settlement for early payment?
The bank requires you to provide a 90-days notice notifying them of your intention to cancel your bond with them. In doing so, the bank charges an early settlement fee based on the amount that the bank would have earned from you in interest charges over the 90 days. This is calculated on a pro-rata basis from the date the bond was cancelled within that 90-days notice period.
Q: What should be noted if you decide to pay off your home loan early?
Once you have paid off your home loan, you can request for the bond registered over the property to be cancelled in the deeds office through a bond cancellation attorney, to whom you would need to pay bond cancellation fees. Should you keep your home loan account open after the account is settled, fees and other charges such as insurance would continue being charged to your account.
Writer : Kerry Dimmer
