One of the best investments a homeowner can make is to pay off their home loan faster to reduce the amount of interest they pay over the term of the loan, says Adrian Goslett, CEO of RE/MAX of Southern Africa.
“While many may think this is a relatively difficult task, especially if they are on a tight budget, a few simple financial adjustments can make a big difference. Taking a proactive approach and using the right strategy can vastly reduce the term of the home loan, and therefore the interest payable on the loan as well as fast-track financial freedom for the homeowner,” says Goslett.
According to Goslett, one of the simplest ways of reducing a home loan term is by splitting the monthly repayment in half and arranging to pay an instalment every two weeks. For example, if the home loan repayment is R5000 a month, the bi-weekly payment would be R2500. This saves on the daily interest over the 15 days between payments, while reducing the outstanding capital and shaving time off the loan term. This simple change will cut a 20-year fixed rate traditional bond by around two years, depending of individual circumstances.
How does this work? Goslett explains that by paying monthly, a homeowner is making 12 payments a year on their bond. However, by paying every two weeks a homeowner is making 26 payments a year as there are 52 weeks in a year. Considering that each payment is half of the normal monthly repayment, the payments will need to be divided by two in order to get to the number of monthly repayments. Twenty-six divided by two is 13. This means that each year the homeowner is making an extra payment, which reduces the compounding effect of interest. Goslett notes that the bank’s agreement to this arrangement will be dependent on the homeowner’s repayment record. Therefore, before using this strategy homeowners are advised to contact the financial institution that holds the bond to ensure that split payments are an option.
Another way that a homeowner can reduce the term of their loan is by adding an extra amount to the monthly instalment. “An increase of R300 on a 20-year bond of R500 000 at an interest rate of 8.5%, will reduce the term of the loan by around three years and save the homeowner a total of R93 937.73 in interest. What is remarkable about this is that if the homeowner had to take the R300 a month and save it for the full 20-year term of the loan at 5% interest, they would only have saved R75 600. This means that it is more beneficial to pay the money into your bond and reduce the interest,” says Goslett.
He notes that drop in interest rate over the last few years has also given rise to an opportunity for homeowners to reduce the term of their loan by simply keeping their repayments the same. “If the home loan is linked to the interest rate, the bank will normally reduce the monthly instalment amount with any decrease in the interest rate. However, if the homeowner opts to keep their monthly instalments constant, they will be paying extra money into their bond account, without adding any additional payment or affecting their budget,” says Goslett. “The interest rate drop from 9% to 8.5% meant that homeowners were paying around R159 less on a R500 000 home loan. By keeping the repayment the same they would be saving R54 923.96 in interest and reducing the loan by about a year and a half.”
Utilising these simple methods can assist homeowners to pay off their bond in a much shorter period of time without too much effort. “Cutting years off a home loan can save consumers large amounts of money and help to ensure that they are financially secure in the future,” Goslett concludes.