Cars, the debt that hurts you more than one thinks. And while it’s not a necessity for all South Africans, having one makes travelling a lot easier. Yes, public transport is on the rise but it’s still out of reach for some, while changing mindsets is a major stumbling block.
So what happens when you buy one, how should you go about financing it? The Stealthy Wealth blog (writer prefers to remain anonymous) is on a drive to retire early (which is apparently a dying breed in the United Kingdom).
In his latest instalment, he looks at using one’s home loan to pay off a car. It’s an interesting concept, which can work if done the right way. – Stuart Lowman
Almost all of us have heard of the benefits of paying off the debt with the highest interest rate first – and it is in fact a very good strategy.'
But some people take this one step further – since home loan interest rates are generally lower than car loan interest rates, you hear them proudly proclaiming “I have paid off my car using my home loan access facility, I am going to save so much interest!” But are they really? Is it a good idea to use your home loan to pay off your car? It can be, but there is a very important aspect which you need to consider.
It is vitally important that you take into account the remaining duration of each loan when using your home loan to pay off your car loan.
Yes the home loan interest rate is lower, but remember a car is generally financed over 54 months, sometimes 60, whereas a home loan is generally financed over 20 years.
What this means is that if you take money out of your home loan and use it to pay off your car, then yes you have financed your car at a lower interest rate, BUT you are now paying the loan over a longer period and you actually end up paying more interest this way.
This is best shown by an example…
Lets say you took out a 20 year home loan with interest at 10% and that it has 11 years to go. It also has an access facility, which allows you to take out the equity that you have built up.
Now say you want to buy a car for R100k (here at Stealthy Wealth we like round numbers), and you were offered finance at 12% over 6 years. But you think you are smart…so you say to yourself, instead of taking a car loan at 12% interest, I will just draw the R100k out of the home loan and pay only 10% interest. Lets see what happens…
The car loan at 12% over 5 years would result in:
Monthly Payment – R2 224
Total Interest Paid – R33 467
If you instead took the R100k out the bond, you would have the following:
Additional Monthly Payment – R1 252
Additional Interest (over 11 years) – R65 262
So by paying for the car out of the bond, you have paid twice as much interest. So much for saving. And the longer you have remaining on the bond, the worse it becomes…If you still had 15 years of payments on the bond you would pay an extra R93 429 in interest.
The trick to get the saving from the lower home loan interest rate is to take the money out the bond, and then pay back what you would have paid on the car loan for the same duration of the car loan.
So for the R100k car with 11 years remaining on the home loan, you should put an extra R2 224 into your bond every month for the 6 year duration of the car loan you would have taken. So it is as if you were paying the car loan.
If you did this you will pay R27 482 in interest instead of the R33 467 from the car loan, thereby scoring an almost R6 000 saving which can be put towards your early retirement.
The same principle would apply to any form of debt (for example taking money out your home loan to squash your credit card, or personal loan, or store account). Always run the numbers first to make sure you are actually saving. You need to be smart with your money, and the only way to know if you are doing the right thing and if you will actually end up saving, is to run the calculations.
• SW is the pseudonym of a South African blogger with a mission to save enough money to be able to stop working at the end of 2030.