Absa recently ran an advert on how you can save 10% on your home loan repayments every month. The problem is that it didn’t mention what this was going to cost in the long run.
Basically, the idea is that you can extend the period of your home loan from 20 to 30 years. Based on Absa’s example of a R500 000 loan amount, you would save about R537 a month on your monthly instalments. According to the advert, this “means that you can use the extra cash anyway you choose”.
This is scary advertising because nowhere does it tell you that extending your repayment period by 10 years will cost you a whopping R400 000 in additional interest payments.
If you are really struggling financially, to the extent that you may have to sell your home, then opting for a longer payment period may save your house. But simply to extend your payment period so you have extra cash to spend must be the worst financial advice I have heard in a very long time.
Take the flip side. Based on the same example in the advert, according to Absa’s online home loan calculator, if you paid an extra R100 into your bond each month, you would save R47 737 in interest payments and reduce your repayment period by more than a year.
It all comes down to compound interest. Any interest you are not paying off is mutating into more interest. Whenever you read articles about investing, they always talk about the power of compounding. This is when you start to earn interest on interest — R10 000 that earns 7% interest turns into R10 700. The next year you are earning 7% on R10 700, which turns into R11 449.
The same applies to debt. If you were lucky enough to borrow at 10,5%, after five years the R10 000 you borrowed would cost you R6 866 in interest if you did not pay it off. The lesson is simple: use compound interest to make money for you, not for the banks.