So there was a recent opinion piece on moneyweb: How To Pay Your House Off In 7 Years.
A pretty broad claim was made:
- Pay 10% extra each month;
- Pay a constant percentage of your take-home salary; and
- Make your payment on the 25th (when you get paid) rather than the 1st – because this could take a year and a half off your mortgage period*.
*I am raising a HUGELY sceptical eyebrow at this one.
Do this, and you could pay off your house in 7 years.
This tip comes from this website: justonelap.com, where you find some disclaimers to said opinion:
- It may mean that you need to buy a smaller home.
- Increase your monthly repayments by 10% each year (rather than just by your salary increase), in addition to the 10% extra each month.
- Keep your savings in your home loan in order to reduce interest (presumably, whatever savings are left, after all the extras).
Allow me to illustrate some compounding:
- In year one, let’s say that your mortgage is R12,500 per month.
- So instead, you pay R13,750 (up by that initial 10%).
- By year 2, you’re up to R15,125
- Year 3, R16,638…
- And so on until year 7, where you’re up to R24,360. Nearly double what you had to pay initially.
So on the one hand – each additional Rand you put in is a contribution to capital, so you automatically save interest. On the other hand, are there better ways to use the money?
Anyway, here’s some modelling.
What does increasing the mortgage repayment by 10% each month and/or by 10% per year do to the loan period?
Here’s the way a mortgage works:
- Each month, you pay back a portion of the initial capital.
- The interest is calculated on the capital that’s left over.
- Over time, with a fixed repayment, you’re paying progressively more capital, and progressively less interest.
So if you can accelerate the capital repayments, you do two things:
- Pay things back quicker in general (because you’re paying more, obviously); but also
- You make your fixed repayments more efficient (because less of the payment will be allocated to interest).
A graph of a 20 year mortgage at 9% on a R2 million property with a 10% deposit:
Bottom line: you cut 4 years off your mortgage repayment period.
Here’s what happens when you escalate your mortgage repayments by 10% a year (that is: you attempt to keep your mortgage repayments as a fairly constant proportion of your salary – sort of):
Bottom line: you cut your mortgage period in half.
Here’s what happens if you do both (an extra 10% per month, and an annual escalation of 10%):
Here’s what happens when you pay on the 25th:
- I pay my first instalment a week early. So I save a week’s worth of interest, which goes toward capital.
- But then my second instalment is no longer a week early. It’s exactly a month later. In which case, I pay a full month’s interest on the full capital amount.
- The only saving is on my very first payment. Which, over 240 months of repayments, gives me a month off.
- Again, unless I’ve missed something.
- If someone has an alternative viewpoint, please point it out. I’d love to say “So listen, making your mortgage payment a week earlier means that you save a year and a half – for doing almost nothing!”
- But as it stands, I just don’t think that’s true.
So let’s just ignore that last, and assume that you pay an extra 10% per month, and you do an annual escalation of 10%. It means that you’ll have paid off your bond, in full, by year 9.
Because I love alternatives.
Instead of paying the money into your bond, let’s put the extras (the 10% per month and the 10% escalation) into a Satrix equivalent. Assuming a 15% annual return, here’s the growth path of your investment (alongside the capital portion outstanding of the standard mortgage):
Assuming that higher return, you could take the Satrix investment and use it to pay off the outstanding capital somewhere in the beginning of year 8.
But if I’m honest – I wouldn’t trade in a mortgage saving for a satrix return. The mortgage rate is almost a guaranteed return. In other words, once you’ve committed to buying a house, every rand of extra capital repaid “earns” a return equal to the mortgage interest rate. And you’ve already committed to the repayment process, so there’s less to be gained from going elsewhere.
So if you’ve already bought a house, pour money into the mortgage. But ignore the advice around the 25th. That’s what I’m saying.
For more in this series of home-ownership:
- Rent or Buy: The Problem with Home-Owning
- Rent or Buy: How To Be A Property Mogul
- Rent or Buy: Why You Should Just Buy A House