Borrowing money to purchase a home is, most often, the biggest financial commitment you will undertake. Knowing how home loans work will help you to make this commitment with a thorough understanding of the implications and the reasons behind the “fine-print”.
In this article, we will highlight home loan essentials:
- What is a Home Loan?
- Is There a Difference Between a Mortgage and a Home Loan?
- Different Home Loan Types
- How do Home Loan Interest Rates Work?
- How Much can I Borrow?
- Does my Credit Score Affect How Much I can Borrow?
- What Happens if I Default on my Home Loan Repayments?
- How to Get Pre-Qualified
- Additional items to consider
Visit our article on how to qualify for a home loan.
What is a Home Loan?
A home loan is a loan issued to you by a home loan provider. The home or property you are purchasing is used as a form of security in case you default on repaying the loan.
A home loan is provided by a licensed bank and is governed by the Banking Code of Conduct and Code of Banking Practice as defined by the Banking Association of South Africa. This code provides you and your home loan with valuable safeguards and good banking practice.
Is There a Difference Between a Mortgage and a Home Loan?
The difference between a home loan and a mortgage is:
- The mortgage bond is registered at the Deeds Office as security to the loan.
- Your home loan is the money the bank is lending to you. Once the bond is registered at the Deeds Office, the bank will pay out the loan amount, usually into the conveyancing attorney’s trust account.
Different Home Loan Types
Variable interest mortgage bond
Variable interest mortgage bond is a type of home loan in which the interest rate is not fixed. Lenders can offer borrowers variable interest rates over the life of a mortgage loan. They can also offer an adjustable-rate mortgage which includes both a fixed and variable rate.
Fixed-rate home loan
A fixed-rate mortgage, which is a fully amortising mortgage loan where the interest rate remains the same through the term of the loan.
How do Home Loan Interest Rates Work?
Variable-rate
Home loan repayments are initially based on a variable interest rate, which relates to the prime lending rate which is determined by the South African Reserve Bank (SARB).
Home loan interest rates are adjusted when the prime lending rate changes. Meaning your monthly instalment could increase or decrease depending on the prime rate changes dictated by the SARB. Hence it is advisable to have additional money just in case.
It is important to put funds aside for an increase in your instalment should the interest rate go up, so that you will be able to pay the higher amount. The good news is that a decrease in interest rate can also occur and it is advisable to save the excess funds for a potential increase in instalment in future.
Fixed-rate
You may be able to negotiate a fixed interest rate with your home loan provider. The benefit of a fixed rate is that the interest rate on your home loan will not change, and you pay the same instalment every month allowing you to budget effectively.
How Much can I Borrow?
Monthly Loan Repayment Factors
Your bank will approve your home loan based on your financial circumstances and level of risk. Some of the factors that will determine your monthly loan repayment are:
- Your home loan could be granted over a longer or shorter period (10, 12 or 24 years) and this will determine your monthly repayment costs. If you opt for a longer period to minimise your monthly commitment, try and pay off more each month. Check if your bank permits you to pay off your loan sooner.
- Your base interest rate will be offered by the bank based on your level of risk. Low risk borrowers may get lower interest rates. (eg. Prime -2)
- Interest rates as defined by the Reserve Bank will determine the fluctuation of your monthly commitment. Don’t be tempted to borrow too much when interest rates are low. Make sure you have sufficient monthly funds to pay your loan back at a higher interest rate.
Does my Credit Score Affect How Much I can Borrow?
Your credit score does affect how much you can borrow.
The higher your credit score, the more money you can borrow, and at lower interest rates which will be an advantage when applying for a home loan.
A bad credit score means the exact opposite of this and results in a low probability of a financial institution being willing to offer you a home loan.
What Happens if I Default on my Home Loan Repayments?
Default or Inability to Repay your Loan
Failure to meet your monthly payment commitments to your bank will find you in hot water.
If you find yourself in financial difficulty, you should let your lender/bank know as soon as possible. Most banks will attempt to find a solution and/or a rehabilitation plan. If you fail to fulfil the rehabilitation plan requirements, a final letter of demand will be delivered to you, the borrower. If you do not respond, the bank can proceed with legal action.
Most banks will monitor any developments or changes in circumstances to see if the dispute can be resolved. Sale in Execution is the bank’s last resort, but is a reality you could face if you fail to meet your payment obligations.
Don’t be Alarmed
Some banks may add a Cover Clause, often referred to as an “Additional Sum” in respect of the Mortgage Bond. It is an amount registered with the Deeds Office to safeguard the bank against any arrears and or legal costs, but does not affect your repayments.
How to Get Pre-Qualified
To get pre-qualified for a home loan you can:
- Approach your bank to see how much they will lend you.
- Approach a home loans consultant with the details of your monthly income and expenditure, including income tax, living expenses and any debts you may have. He will calculate your pre-qualification amount in accordance with the guidelines of the National Credit Act, and determine your credit score.
- Approach your Leadhome Property Consultant who will refer you to one of our tried and trusted professionals to guide you on how to prequalify for a home loan.
Click here to find out how to prequalify.
Additional items to consider
Other Monthly Costs
Aside from your monthly loan repayment, there are other monthly costs you will be required to pay in order to secure your home loan. These include:
- Homeowners Comprehensive Insurance.
- Mortgage Protection Cover (Life Assurance).
- Other optional insurances and value-add products include:
- Disability Insurance.
- Household Content Insurance.
- Loss of Income Insurance.
Once-off Costs
When budgeting, remember, there are other associated costs. These are the most common once-off costs:
- Deposit. Depending on how much you intend to borrow, the bank may require you to pay a deposit. This will be the difference between the purchase price and the amount of the loan.
- Transfer duty. This is payable to SARS.
- Bond registration or initiation fees.
- Conveyancing fees.
Summary
A home loan is often the “cheapest” way of borrowing and an important means for you to step-up on the “property-ladder”. Very few people can afford to save up to buy a home without a home loan. As with most things, shop around for the best home loan offer.
