For interest's sake
First-time homebuyers often do not realise the financial impact paying a higher interest rate can have over the long run.
What is an interest rate?
The interest rate is, quite simply explained, how much it costs to borrow money. It is determined as a percentage of the amount of debt incurred. The interest rate is linked to the repo rate, which is set by the Reserve Bank of South Africa. This is determined taking factors into account such as the general wealth and economic growth of the country and consumer spending.
The South African Reserve Bank kept its benchmark repo rate steady at 6.5 percent on 19 July 2018. Interest rates in South Africa averaged 12.61 percent from 1998 until 2018, reaching its highest ever rate of 23.99 percent in June of 1998 and a record low of 5 percent in July 2012. (Source: Trading Economics)
The prime interest rate as at end July 2018 is 10%. When prospective homebuyers apply for mortgage bonds, banks may consider offering lenders a prime rate minus certain percentage points or fractions thereof, or a prime rate plus a certain percentage point or fractions thereof.
The mechanics of interest
One earns interest on savings and investments and pays interest on debt. The interest you earn is always lower than the interest you would pay on your debt. This is because financial institutions are businesses and as such, need to make money. They make money by lending money (providing credit) at a high interest rate and paying lower interest rate to access the funds from their investors.
It is very important to earn an inflation-beating interest rate when investing money to ensure your money grows over time. When paying off debt, it is important to secure a low interest rate to limit your overall repayment over the loan term.
Mortgage bond debt and the interest bondholders pay
Let’s take a look at Ashley’s deal. He recently purchased a three-bedroomed, two-bathroomed townhouse in Buh-Rein Estate’s Saronsberg Close for R1 660 000.
Ashley had R250 000 available, which is around 15% of the purchase price, as a deposit. He had to budget around R90 000 for the transfer costs and bond registration costs, resulting in his total debt at the point of purchase being R1,5m.
Ashley’s monthly repayments at the prime rate of 10% over a 20-year period on his mortgage loan of R1,5m works out to just under R14 500 per month. If he could get his interest rate down to prime minus 0,5%, the monthly repayment would be just under R14 000 per month.
The R500 he saves every month by paying a 0,5% lower prime rate may not seem like such a big deal, but this is exactly where compound interest plays a role. If Ashley paid his home off over 20 years at an interest rate of 10%, his home would cost him R3 474 000 over the repayment term. However, if Ashley paid his home off at an interest rate of 9,5% over the 20 year term, his home would cost him R3 356 000 over the 20-year term.
It is now obvious why it is advantageous to secure the best possible interest rate when taking out a loan. The 0,5% reduction in interest rate saves Ashley a phenomenal R118 000 over 20 years.
What could help first-time homebuyers secure a better interest rate?
- First things first, as a consumer you have to ASK the bank(s) / financial institution(s) whether you qualify for a better interest rate.
- Prospective homeowners can shop around and request a homeloan from more than one bank to gauge which bank offers them the best terms.
- Ask your own bank where you hold an account if they cannot improve on the best rate you’ve received from another bank. Banks who already has some of your business, are usually keen to gain more business from you because they have a history of your dealings with them.
- A clean credit record and a history of prompt repayment of debt will stand you in good stead when applying for credit.
- A sizeable deposit usually helps prospective homeowners to secure better loan terms because the bank’s risk is reduced when you don’t require a 100% loan.
What should you be paying?
The short answer to this question is “as little as possible”. Make use of our bond calculators to see how much your home loan will cost you and how much money you need to earn to qualify for your home loan.
Author: Rank Real Estate