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A Fin24 user building his house out of his pocket ran out of
money and had to take out multiple loans. He writes:
I tried to build my house out of my own pocket in 2011.
I started with R300 000 and during the process I ran out of
money, because I didn't know it would be so much after using a reasonable builder.
I was actually forced to borrow another R120 000 and on top
of that I used about R60 000 from my credit card.
I have actually discovered that my personal loan which is
over 5 years will cost me R252 000. (R4 200 x 60) accept the credit cards.
I just want to pay off my biggest debt which is the personal
loan. I am currently paying R4 200 per month.
Will my interest be less when I pay an amount of R4 500 or
R5 000? I owe this company about R85 000.
1) Will they penalise me if I pay it off earlier?
2) Must I use as much money to pay off my principal debt or can I go on to save or invest money that I
have left over at the end of the month?
Malcolm Berry, Sanlam market specialist, responds:
The background facts you provide are a bit unclear – I will,
however, try and put into perspective the problems you have in line with your
questions.
In short, I assume you initially applied for a R300 000 bond
(or building loan), but then you had to borrow an extra R120 000 (via your bank i.e. a personal
loan) plus an additional R60 000 on your credit card?
If my interpretation is correct, you should be paying different interest rates on each of the above amounts. The reason I assume this is that a long-term debt (like the R300 000) will levy interest at a lower rate, whereas a personal loan's interest rate would be levied at a much higher rate.
I assume therefore that the R300 000 "bond"
pay-back term is 20 years whereas the personal loan debt is repayable over a 60-month period (5 years). Whenever a
person’s pay-back term is shorter, the interest
rate would automatically be higher.
You state that your personal loan pay-back amount is R4 200
pm. This pay-back amount includes interest that the bank is levying as well as part of the capital that
was borrowed. The same would apply to the "bond" repayment amount (you haven't mentioned the
amount).
Generally speaking (and it also depends on your personal
standing with your bank), the interest on a bond would be charged at what we
call "prime rate of interest". At the moment this is 8.5%.
Depending on each person’s credit standing, earnings etc;
you may qualify for a rate of Prime minus 1 (unlikely in today's current
economic climate), or Prime, or even Prime plus 1%.
On the other hand, personal loans and credit card interest
rates are levied at a much higher rate than the Prime rate e.g. anything
between 12% and 22%.
Based on these points I have highlighted, my answers to your
questions are as follows:
1) The interest will not necessarily be levied at a lower
rate if you pay more e.g. R4 500 on the debt –
however, what will happen is that you will pay off your debt quicker
than if you paid only R4 200 pm.
2) You should not be penalised if you were to pay off your
debt earlier than contracted....what it may well do is improve your standing
with the bank for future credit applications.
3) Paying off your debt is always considered the best
financial practice. However, your personal circumstances would dictate what the
best option would be.
The general rule that is applied is that if the interest on
your debt is levied at a higher rate than what you could get on an investment,
it would be better to pay off the debt. For example, if your rate of interest
is 22% (like the credit card debt) and the investment growth is 10%, it is best
to pay off the debt of 22% than receive a 10% interest rate on an investment.
If you did not have any "short-term" debt (like
the credit card/personal loan), my answer may well be different here because
you MAY get better returns than the interest rate payable on a long-term debt
like a bond.
In summary, I would therefore suggest that you pay off your short-term debt as soon as possible because it is costing you the most and the sooner you dispose of it the sooner you can invest in a suitable investment for the future.
- Fin24
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