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How do home loans work?
A financial institution typically provides a home loan to help successful applicants buy a property. Usually, you must contribute to the property purchase in the form of a deposit – a lump sum of cash that you have saved over time. The financial institution then advances you the remainder of the funds (known as the principal) to purchase the property and takes out a mortgage over it.
You are then required to repay the loan in weekly, fortnightly or monthly instalments over a set period (e.g. 30 years), as well as interest and fees. If you cannot repay your loan, the financial institution can sell your property to recoup the money they lent you.
How do banks calculate home loan interest?
Your lender will usually calculate the interest on your home loan at the end of each day. At the end of each month, your lender will add up your daily interest charges. This is the monthly interest amount generally found on your bank statement.
Let’s take a look at how your daily interest charge is calculated on a home loan. Say your loan balance is R400,000 with an interest rate of 4.5% per annum. First, you would multiply the home loan balance (400,000) by the interest rate (0.045) and then divide it by the number of days in the year:
(R400,000 x 4.5%) / 365 = R49.31)
It’s worth keeping in mind though that lenders utilise something called an amortisation schedule, which lets the lender lay out every single scheduled repayment you’d need to make to pay off your home loan (if you didn’t refinance or otherwise change your home loan). The lender then decides how much of each repayment will be comprised of interest charges and how much will go towards your home loan principal, with lenders typically opting to ‘frontload’ much of your home loan interest.
This in turn means that the home loan repayments you’re making in the early stages of your loan term will likely not be making too much of a dent in your loan principal, but later on in the loan term your repayments will make much more of an impact on the principal and have a smaller interest component.
How much will my home loan repayments be?
Your repayments will depend on:
- The type of loan you’re taking out
- The principal amount of the loan
- The interest rate
- Its repayment frequency
- The length of the loan term.
If you know these details, find out how much your loan repayments could be using our handy home loan repayment calculator.
