Should you pay off your car using your home loan?
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, says Stealthy Wealth, a blog site run by an embedded software engineer with degrees in electronic engineering and IT, who is on a mission to retire by the age of 45.
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 (240 months). 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.
Stealthy says: “Despite the lower interest rate, using a 20-year home loan to pay off a 5-year car loan is a bad idea”
Let’s 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 R100,000 (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 R100,000 out of the home loan and pay only 10% interest. Let’s 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 R100,000 out of 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 R100,000 car with 11 years remaining on the home loan, you should put an extra R2,224 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 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 doing the right thing and if you will actually end up saving is to run the calculations.
This article is republished with the kind permission of Stealthy Wealth, a blog site run by an embedded software engineer with degrees in electronic engineering and IT, who is on a mission to retire by the age of 45.
*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!
Disclaimer: The information above is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort offered or endorsed by HomeTimes and Stealthy Wealth. Any expression of opinion is personal to the author and the author makes no guarantee of any sort regarding accuracy or completeness of any information or analysis supplied.