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Tuesday, 31 May 2016

Using Your Home Loan To Pay Off Your Car

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A house squashing a car - is that the
best I could come up with? 
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 60whereas 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.
Despite the lower interest rate, using a 20 year homeloan to pay off a 5 year car loan is a bad idea.
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 5 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 - R2224
Total Interest Paid - R33467

If you instead took the R100k out the bond, you would have the following:
Additional Monthly Payment - R1252
Additional Interest (over 11 years) - R65262

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 R93429 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 R2224 into your bond every month for the 5 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 R27482 in interest instead of the R33467 form the car loan, thereby scoring an almost R6000 saving which can be put towards your early retirement!2

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 doing the right thing and if you will actually end up saving is to run the calculations.



Till next time, Stay Stealthy!

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1 When Mrs. Stealthy Wealth bought her first car back when we were still dating, she got a 60 month finance deal at something stupid like prime + 4%. I've told her numerous times since then that she is lucky we were only dating, if we were married I would NEVER have allowed it!

2 Of course what is better than any of this is to never take out car finance in the first case - but that is a topic for another day...