There are many different types of loans and methods of calculating and repaying interest. Your home loan is quite possibly the longest loan commitment you will make, so it’s critical to understand how the interest is calculated over the life of the loan, and what each repayment is actually made up of.

Types of Interest

There are a few ways that interest can be calculated on a loan:

• Simple interest is calculated using the principal only and is calculated by multiplying the loan's principal amount by the annual interest rate by the term of the loan in years;
• Compound interest is calculated on the principal amount and any accumulated interest from previous periods, meaning you pay interest on your interest.
• Amortisation refers to a loan repayment schedule where each payment covers both the principal amount and the interest owed, with the proportion of each shifting over time whilst the total repayment stays the same.

Home loan interest

Home loans in South Africa are typically based on amortisation, which results in a fixed repayment linked to your interest rate (fixed, so long as the interest rate remains constant), but varying contributions towards principal loan and interest amount for each repayment.

Amortisation is suitable for longer loan terms where a specific repayment is required for a specific budget, making it easier for borrowers to manage their debt over the loan's term, and for lenders to receive regular payments.

How amortised interest works

With a home loan, your initial payments will have a larger portion going towards interest, and as you pay down the principal, a larger portion of each subsequent payment will go towards the principal.

Key Features of an amortising loan include:

• Equal Payments: Amortised loans typically involve equal periodic payments (e.g., monthly);
• Principal Reduction: Each payment reduces the outstanding principal balance; and
• Interest Reduction: As the principal balance decreases, the amount of interest paid in each subsequent payment also decreases.

Home Loans, front-loaded interest

Because of amortisation, the interest on your home loan is front-loaded. In the early years of the home loan term, a larger portion of each payment goes towards paying off the interest rather than the principal balance. This is because the interest is calculated based on the outstanding principal balance, and since the principal balance is higher at the beginning of the loan term, the interest amount is higher.

As the home loan matures, and more payment are made, the principal balance decreases. Consequently, the portion of each payment allocated to interest gradually decreases, while the portion allocated to paying down the principal gradually increases. This is why, over time, more of each mortgage payment goes towards reducing the principal balance and less towards paying interest.

Understanding how home loan interest is front-end loaded is crucial in making informed financial decisions, particularly around setting up an access facility and maximising the benefits from it.

Use a reputable mortgage broker

Using a reputable mortgage broker ensures you get the most of your biggest financial asset, with competitive rates and relevant advice. Phoenix Bonds is a premium finance broker with over 35 years’ experience in the property finance sector in South Africa.

Phoenix Bonds is more than just a home loan comparison service. Their expertise lies in:

• increasing financial literacy and awareness for their clients,
• ⁠identifying key opportunities,
• formulating intelligent solutions,
• meticulously representing their client’s best interests; and
• facilitating their client’s choices with precision.

For a free consultation around your property finance transaction, fill in your details HERE and an experienced Phoenix Bonds Mortgage Broker will be in touch.