Buying a house is no easy matter – there is a lot that you have to know and a lot that you have to do other than the simple finding and purchasing of a house. The most important of these tasks, is perhaps the home loan that you will borrow in order to buy your house – so that you can pay off the total amount of money slowly in monthly installments. You should know, however, that it isn’t as simple as adding he amount of the loan to the total interest on that amount and then divide this entire amount by the total number of months that the loan has been taken for. The process of calculating the interest on your home loan is slightly more complicated than that.
The basic differences between different methods of calculating interest
There are different ways to calculate interest – banks and moneylenders have their own individualized methods of calculating interest depending on the laws of the country they are from and the type of loan that they have given the borrower. These ways differ on the basis of the interest rate, the time period of the entire loan, the time period after which the interest is calculated and the kind of interest that they ask for.
The way interest is calculated on home loans
Interest on home loans is calculated on a daily basis, for one month at a time, using an interest rate that is projected for a year. Because it is calculated on a daily basis, the interest is calculated on the amount of the loan that is left unpaid each day. So if this balance is diminished in the middle of the month, the calculation becomes a little more complicated than a simple multiplication process.
An explanation with the help of an example
Say the total amount of your home lone is R400 000 and the current interest rate is 13.5% per annum. For the month of March, which has 31 days, the interest will be calculated as follows:
13.5/100 X R400 000 X 31/365 = R4586.30
But because the balance decreases with every installment that is credited from your bank account, the calculation is not that simple. Say on the 25th of March, you pay off part of the total loan and the balance decreases by, say, R5000. This means that the interest will be calculated on the total amount till the 24th and then on R395 000 for the rest of the month.
So till the 24th, the interest will be:
13.5/100 X R400 000 X 24/365 = R3550.68
And for the rest of the 7 days the interest will be:
13.5/100 X R395 000 X 7/365 = R1022.67
This makes the total interest payable for that month R4573.35
How to reduce the interest
It is obvious from these calculations that the sooner you pay off your home loan, the less interest you will have to pay. Interest rates change and therefore you will find yourself paying more interest for the same amount of money with every successive year; this is another reason to pay off the loan faster.