We are going to explore some technical details in this post. An extremely critical part of property investing is how to pay back a loan. This calculation is called an amortisation calculation. Despite its importance, there is very little understanding of how it works.
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The process of writing down the value of either a loan or an intangible asset.
Using this definition, we can establish that this is the calculation used to pay back a loan. Typically, in property investing, one would take out a home loan from the bank to buy the property. The bank would then calculate the payback of the loan based on several criteria:
- Duration of the loan. In residential property, this is usually 20 years and in commercial property, it is 10 years.
- The interest rate. In South Africa, the interest rate is based on the prime lending rate that the reserve bank lends money at.
- What the purchase price of the property is
- Less the deposit paid
- More commonly, this is the initial loan that the bank has made to you. Also called the Principle Value.
There is a formula that is used for calculating the payback of the loan. This formula calculates the monthly instalment that is needed to be paid throughout the loan period.
Just remember, the basic calculation does not take into consideration any changes in the interest rate or additional payments made into the loan account. These factors are only calculated when the changes occur and into the future of the duration.
Let us take a look at the formula:
This might look very confusing, so let’s do an example:
We purchase a house for R500,000 (Loan Amount/Principle Value) and takes out a 100% bond from the bank. The bank gives us an interest rate of 8.75% (r) over 20 years (t). As we are paying the bank the instalment monthly, the number of payments per year is 12 (n).
- Loan Amount – R500,000
- r – 8.75% = 0.0875 (divide the percentage by 100)
- t – 20 years
- n – 12 payments per year
Thus, the total monthly repayment for this loan would be R4,418.55.
Did you follow this calculation?
Don’t worry if this all looks Greek to you. There are plenty of online calculators and spreadsheet formulas that you can use.
The easiest way to perform this calculation is to use an online calculator like the one on Ooba’s website.
If you like using spreadsheets and Excel, the equations will look like this (using the PMT function):
When you are repaying a loan using the standard Amortisation calculation, there is a portion of this amount that is the loan repayment (principal) and a portion that is the interest payment. It is well known that the vast majority of the first several year’s payments will mostly be interest.
Did you know that it takes 12 years of a 20-year loan for the amount going towards the principal payment to be more than the interest amount? So, for the first 12 years, most of your payment is toward interest.
This graph shows the monthly instalment, broken into principal payments and interest payments of the above example.
From the above calculation we can work out the following:
- Monthly instalment: R4,418.55
- Total Principle Amount: R500,000.00
- Total Interest Paid: R560,452.85
- Total Paid over 20 Years: R1,060,452.85
Do you already own a house or an investment property? Why don’t you look for your last statement from the bank and run this calculation. You should be able to work out to your monthly instalment. Don’t forget that the interest rate has recently been decreased by 1%, so with this in mind, perform your instalment calculation before the interest rate dropped and after and see how much money you will be saving.
If you are looking for more advanced calculations to produce the above graph and calculate your interest paid in each instalment or the total interest paid, let us know in the forum and we will gladly assist you with all of the formulas.
We hope this gives you some more insight into how your loan calculation is calculated. Be sure to leave us a comment in the forum and let us know if this calculation makes sense to you.