One small number can make a massive impact on your overall financial wellbeing
While you might think it insignificant, interest rates actually play a crucial role in determining the cost of your home loan and can significantly impact your monthly repayments, total loan cost, and overall financial security.
According to Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa, many buyers overlook the importance of maintaining a good credit score to obtain the lowest possible interest rate on home financing.
“Rather than focusing on which bank offers you the highest possible credit amount, focus on the bank that offers the best interest rate, as this will have the largest lasting impact on your finances,” he advises.
How do interest rates affect your finances?
At the most basic level, higher interest rates mean higher monthly repayments, making it more expensive to service your bond. Over a long loan term, even a small difference in the interest rate can result in paying significantly more in interest.
To illustrate just how much an interest rate can affect your finances, let’s use an example of a R1,000,000 loan taken over 20 years at an 11% interest rate compared to a 12% interest rate. Just this 1% increase in interest results in R690 more per month. Over 20 years, you pay an extra R165,354.58 in interest alone.
| Interest Rate | Monthly Repayment | Total Repayment (20 years) | Total Interest Paid |
|---|---|---|---|
| 11% | R10,321 | R2,477,252.14 | R1,477,252.14 |
| 12% | R11,011 | R2,642,606.72 | R1,642,606.72 |
According to Goslett, securing a lower interest rate at the initiation of your home loan is incredibly important, especially when you understand how the amortization process works. “This is the process of gradually paying off a loan through scheduled monthly payments that cover both interest and principal. In the beginning, a larger portion of your payment goes toward interest, while a smaller portion reduces the principal. Over time, as the principal decreases, the interest portion decreases, and more of your payment goes toward paying off the loan balance,” he explains.
Because interest is calculated on the remaining balance, Goslett explains that at the start of the loan, the outstanding balance is at its highest, meaning interest charges are also at their highest. Each time you make a payment, your principal balance shrinks slightly, which also means that the interest portion of your payment gets smaller over time. It is only roughly fifteen years into your loan term that you start paying more towards the capital amount than you do towards the interest.
| Year | Interest | Principal | Ending Balance |
|---|---|---|---|
| 1 | R109,279.29 | R14,583.32 | R985,416.68 |
| 2 | R107,591.73 | R16,270.88 | R969,145.80 |
| 3 | R105,708.88 | R18,153.73 | R950,992.08 |
| 4 | R103,608.15 | R20,254.46 | R930,737.62 |
| 5 | R101,264.33 | R22,598.28 | R908,139.34 |
| 6 | R98,649.28 | R25,213.32 | R882,926.02 |
| 7 | R95,731.63 | R28,130.98 | R854,795.04 |
| 8 | R92,476.34 | R31,386.27 | R823,408.77 |
| 9 | R88,844.36 | R35,018.25 | R788,390.52 |
| 10 | R84,792.09 | R39,070.52 | R749,320.01 |
| 11 | R80,270.89 | R43,591.71 | R705,728.29 |
| 12 | R75,226.51 | R48,636.10 | R657,092.20 |
| 13 | R69,598.40 | R54,264.21 | R602,827.99 |
| 14 | R63,319.01 | R60,543.60 | R542,284.39 |
| 15 | R56,312.97 | R67,549.63 | R474,734.76 |
| 16 | R48,496.21 | R75,366.40 | R399,368.36 |
| 17 | R39,774.90 | R84,087.71 | R315,280.65 |
| 18 | R30,044.36 | R93,818.24 | R221,462.40 |
| 19 | R19,187.83 | R104,674.78 | R116,787.62 |
| 20 | R7,074.98 | R116,787.62 | R0.00 |
“Understanding how this works helps buyers to understand how making extra payments early into the loan term can significantly reduce the total interest paid and shorten the loan term. It also helps to understand how significant of an impact it makes when the SA Reserve Bank lowers or raises interest rates for the country,” he notes.
“Ultimately, understanding how interest rates work will help you make informed decisions when taking out or managing a home loan. If you are unclear about anything, set up an appointment with a financial advisor or a bond originator to help gain a better understanding. Once you are ready, reach out to a RE/MAX agent to start hunting for a house you can truly afford,” Goslett concludes.
