How does interest work on a home loan

Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa, explains that by understanding how home finance works, potential homeowners can better manage their finances and enjoy greater financial freedom.

Before applying for a home loan, buyers need to understand that on top of paying off the capital amount, they will also be charged interest (which is essentially the cost banks charge for borrowing money). These interest charges will make up a significant amount of the home loan repayments.

“Amortization is the process of paying off a debt over time in regular instalments. Each payment contributes to both the principal and the interest. Early in the loan term, a larger portion of the payment goes toward interest. As the loan term progresses, more of the payment goes toward reducing the principal amount,” Goslett explains.

For example:
Loan Amount (Principal): R1,000,000
Annual Interest Rate: 11.75%
Loan Term: 20 years (240 months)

Monthly Payment: ±R10,860.49
First Month’s Interest Payment: ±R9,792
First Month’s Principal Payment: ±R1,068.49
239^th Month’s Interest Payment: ±R209.43
239^th Month’s Principal Payment: ±R10,651.06

“When you understand how the amortization process works, you can see how beneficial it can be to pay extra towards your home loan in the early years to chip away more towards the capital repayments and, in the long run, minimise how much interest you will end up paying,” Goslett explains.

To add to the first example, by paying an extra R500 per month during the first ten years of the home loan in the example provided, you would save approximately ±R496,567.92 in interest over the life of the loan.

“It is important to understand how home finance works so that you can make more informed decisions about your finances. For those who can afford to do so, paying extra towards your home loan can unlock even greater financial benefits for homeownership,” Goslett concludes.

Writer: Kayla Ferguson