The question of whether it is better to pay off debt first or put money into savings is one with which most of us have had to grapple.
As a rule of thumb, paying off debt first is usually the appropriate answer, as interest accrued on debt is often much higher than interest earned on savings.
“For homeowners who have taken out an access bond and who are in the early stages of their loan term, I would always recommend reinvesting any spare cash into their home loan, as this could end up saving them significantly more in repayments than any additional savings account is likely to earn them. Having an access bond also allows homeowners the ability to withdraw funds in case an emergency arises, and therefore acts as a savings account at the same time,” explains Regional Director and CEO of RE/MAX of Southern Africa, Adrian Goslett.
For those with an access bond, read more here: Don't use your home loan like an ATM
“By means of a practical example, if you invest just R250 per month for 12 months into an interest-bearing savings account at an interest rate of 7% per annum, you will earn R3,017.50. Alternatively, if you are in the third year of your 20-year loan with an interest rate of 10.25%, you pay an extra R250 per month into your home loan for just 12 months, you will save R15,000 in interest payable over its lifespan,” Goslett explains.
“That being said, if you invest the same amount into your home loan but you are in the final year of its 20-year lifespan, you will only reduce the interest you pay by R170. The tipping point in this scenario in deciding whether to put the money into savings or reinvest it into your home loan is at around year thirteen of its 20-years, where you will reduce the interest you pay over the lifespan of your bond by R3,500. Later into your loan term, you are likely to be reducing the interest payable by less than what you could be earning in an interest-bearing savings account,” Goslett explains.
“Timelines therefore have a significant role to play in weighing up whether to save first or to pay off your home loan faster – and compound interest is largely to thank for this. In the earlier stages of your home loan, the majority of your monthly instalment goes towards paying off interest. That is why investing into your home loan during these early years will dramatically decrease your loan term and the total interest payable, potentially saving you a lot of money.”
“However, if you are nearer to the end of your home loan term, it is advisable to invest any additional funds into a savings or investment account as this will earn you more than adding to your loan instalments will save you.”
As a final piece of advice, Goslett suggests that homeowners consider keeping their home loans open when they near the end of their loan term. “Since the interest charged on a home loan is invariably less than the interest charged on a personal loan, it will cost less if homeowners take out money against their pre-existing home loan than it would to refinance their home from scratch or to take out a personal loan in order to access money on credit,” Goslett concludes.