To understand what your home loan repayment is made up of (in terms of principal and interest), you first need to understand compound interest, and how it works in reverse for debt.
Let’s say you put R10,000 into a savings account with a 10% interest rate that compounds annually. At the end of the first year, you'll have R11,000 - the initial R10,000 in principal plus R1,000 in interest. That R1,000 is "simple" interest - interest based only on the principal amount invested.
At the end of the second year, you'll have R12,100 - the R11,000 from the previous year plus R1,100 in added interest (10% of R11,000). Instead of calculating interest based only on your original principal, compounding interest calculates your annual interest based on the principal plus any previous interest you earned on that principal.
By the end of the 10th year, you'll have R25,940 - more than double your initial savings (without adding any more of your own money after your initial investment).
However, if you change the compound frequency, this will affect the amount. For example, if we change the formula above to compound monthly, rather than annually, the end result in the 10th year would be R27,070.
While compound interest can help your savings grow more quickly than it would with simple interest, it can also work against you when you're borrowing money. For a debt scenario, the formula is reversed.
Home loans typically compound interest monthly based on the principal and already-existing interest from the previous period. In other words, you don't pay interest only on the principal amount, but you pay interest on the principal amount plus the interest accrued. This is best shown in what’s called an amortization schedule:
On the schedule, you will notice that more of each payment in the beginning goes towards interest charges, while in the latter half of your amortization, more of each payment goes toward paying off the principal amount. This is important because the longer your amortization period, the more interest you will pay over the life of your mortgage. The more interest you pay, the longer it takes to pay off your principal and gain equity in your home.
This also highlights how putting extra money into an Access Facility that either reduces loan term or interest paid allows you to pay less total interest over the life of your loan.
In short, the faster you can get to paying off your principal, the sooner you can pay off your mortgage, own your home and benefit from the asset.
Paying off your home loan faster will save you money in the long run, but so will using a mortgage broker. Apply for your home loan through Phoenix Bonds – we will simultaneously submit your application to up to 10 banks, negotiate on your behalf and ensure you get the best possible interest rate.
The best part – our services are completely free!
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