In 2019, I participated in an insightful session on employee financial well-being. Home loans were a hot topic. The employer had an agreement with its pension administrator and one of the banks to allow pension-backed home loans to its employees. While we were in the midst of discussing what could go wrong and some benefits of this arrangement, a man who had a calm demeanor about her casually cleared his throat and almost whispered why he needed help. a mortgage to finance a property. Baffled by this question but trying to stay calm, the mortgage bank consultant said, “Well, that’s the only way. “
“I understand you,” replied the gentleman, “but let’s say I’m using a personal loan, there’s a good chance I’ll pay off the house in five years or less, and if I don’t pay off the loan my house won’t pay off. ‘is not in danger, ”he said. added.
As I sat there watching this back and forth between the two of them, I thought long and hard about what he had just said. To say that your home would not be in danger if you did not pay off a personal loan is not accurate. It can be a much longer process to tie your home down to debt, and it’s a long and arduous legal process that most financial institutions prefer to avoid. But it is possible. He was right, however, that you could pay off a personal loan in five years. But at what cost ? Assessing the adequacy of credit facilities is one of the building blocks of using credit to build wealth. The problem with credit is that the most convenient way isn’t always the most efficient. But before I explain why it is essential to use a proper credit facility, let me first describe the two types of loans, so that you understand them better.
A personal loan is like a type of flexible credit. It is not intended for any specific use, which means the bank will not regulate how you use the money. Most people use this type of credit to help pay for school fees, plan vacations, or pay unexpected fees. For banks to approve this loan, they look at your credit history and personal information (e.g. are you employed, are you earning enough income to pay off the loan, your lifespan, etc.). You can get up to R300,000 in South Africa as a personal loan from a reputable credit provider. Personal loans are unsecured loans because they have no asset backing the loan and generally attract high interest rates.
A home loan is a more fixed type of credit to use for a home purchase. People who are considering buying a home or doing major renovations will consider this type of credit. For the banks to approve this they will do a credit review, yes, but they will also look at the type of property you are considering buying and its value. You won’t be able to go to the bank and ask for 1 million rand when your property is worth 300,000 rand. Likewise, suppose after the bank looks at your credit history and personal information, they feel that you are not worthy of a million Rand loan. . In this case, they may ask you to either downsize your property and find a smaller and cheaper one, or improve your affordability, especially if you are planning to take out a 100% no deposit loan.
Home loans are a type of secured loan because there is an asset attached to the loan. In the event of default, the asset can be repossessed and sold to recover the borrowed funds.
In most cases, home loans enjoy relatively reasonable interest rates.
There may be reasons one would use a personal loan to finance a home purchase, often because many people do not qualify for home loan approvals. It is unfortunate, because it puts a person in a difficult position. The high interest rates on personal loans mean you end up paying a lot more in interest costs than if a home loan were used.
Second, to be eligible for Flisp, the government-funded home ownership grant, a home loan must first be approved.
Finally, it is essential to remember that even if the borrowing period of a mortgage is 20 years, it is only the maximum number of years to repay the loan. If you have the privilege of putting additional amounts into the home loan, it will reduce the number of years to pay it off and significantly reduce the amount of interest paid on the overall loan.
The math of how these loans work is also essential. The interest you pay on any loan is calculated using the interest rate you are offered over the outstanding balance you owe. Remember that on a personal loan, it is significantly higher than the interest rate on home loans. The trick is to try to reduce the outstanding balance as much as possible.
At the start of a loan repayment, a significant percentage of the minimum monthly payment you make is allocated to the interest portion of the loan. Any additional amount you make will be used to reduce the balance owing to 100%. A personal loan will have a higher monthly payment than a home loan for the same balance due. This means that on a personal loan you may not have the luxury of paying extra, while the terms and conditions offered on a home loan allow for additional payments.
For example: on a personal loan of R300k over six years and an interest rate of 15%, you will pay a monthly repayment amount of R6,438. For a home loan of R300k (no deposit) over 20 years and a rate of d 9% interest, you will pay back a monthly amount of R2 699. This makes a difference of R3 739 between the two loans. But if you were to pay R6,438 on a home loan and recalculate the down payment term, it is reduced to 4.8 years which is less than the personal loan term. And you can’t argue with math!
Note that a personal loan is not used to accumulate assets that have substance. Think about the end goal and the generational wealth you could build instead of taking shortcuts to have a higher price in the end.