How to…calculate loan repayments

Here’s one for you…what’s the cost of borrowing money? Interest! Yes, it is interesting, but I’m saying that the cost of the loan is the interest rate that the bank charges you to borrow the money.

Nothing is for free and the bank certainly makes its money from the transaction. You don’t have to be a maths genius to work it out either…if you borrow R1,000 for one year and the bank charges you 10% for the benefit of the loan, you’ll have to pay back R1,100 at the end of the year. That’s the basic principle. It only gets more complicated when we use different numbers and loan periods, and chuck in some decimals, but even then you can go online and use a calculator to work out what you would pay.

Before we move along, I have to give my 2 cents worth. If you know me from previous articles, you’ll know that I am fundamentally against borrowing money. There are circumstances where it is necessary, for example purchasing a home or taking a study loan, but to take a loan to purchase wants as opposed to needs is just crazy. Save up a little more and wait a little longer and buy the item for cash. You’ll save money and a whole lot of admin time. Plus, you won’t have a big financial institution breathing down your neck.

So you definitely require a loan to purchase something that you need because you can’t afford it now and you don’t have time to wait. Google ‘home loan calculator’ or ‘car loan calculator’… the principle is the same so even if it is a student loan it shouldn’t make much difference. How often your bank automatically calculates the interest on your loan will change the number a little, but not severely, so we’ll ignore that for the time being. Follow the search results to the website of a well-known brand of bank, other financial institution or real estate agency.

Things you need to know are the cash price of your purchase, the number of years (usually stated in months) over which you’ll be taking the loan, and the bank’s interest rate. Once you have plugged in that information, the result can be calculated which is your premium – the monthly amount that you will pay.

Putting down a deposit makes a massive difference to the premium you will pay so make every effort to do so. You’ll also look good in the eyes of the bank so you could get a better interest rate (the smaller the number the better!). The way to calculate the result is just to put in the amount that you need to borrow after having paid the deposit.

Look out for administrative charges and commissions. They should be paid from the interest that the bank charges, and not an additional charge.

When purchasing a car, be very careful of balloon payments and residuals. They bring down the payments significantly but you won’t own the car at the end of the period. If you want to own it you’ll have to pay in a lump sum of money, often around 35% of the original purchase price of the car. It’s a very tricky financing plan and is more suited to employees that have car allowances. As a student I would avoid the temptation to enter into this type of contract.

Finally, if you take a loan, pay it off as soon as possible. Just making one double-payment will reduce your total payment term. If you have spare cash, use it to pay off debt. If the debt is costing you 10% and a savings account is paying five, the benefit is enormous. Always take time to make the decision, ask a lot of questions and understand the details. If you are uncertain, don’t make proceed until you feel more comfortable.

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Profile photo of Jason Bernic CFP®, Financial Planning Coach, Old Mutual Wealth.
Jason Bernic CFP®, Financial Planning Coach, Old Mutual Wealth.
Jason Bernic is a Financial Planning Coach at Old Mutual Wealth, a new advice-led investment business. He is a Certified Financial Planner and a member of the Financial Planning Institute. His 11 years of experience include personal financial planning for individuals and offshore investment. He is passionate about advice and focuses on the client, not the client's money.
By Jason Bernic CFP®, Financial Planning Coach, Old Mutual Wealth. (See all)

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