By Tokiso Nthebe
The exercise of spending many hours crunching numbers or working through an Excel spreadsheet robs many non-finance professionals of their joy. Not only is the exercise daunting because people derive no pleasure from it, but generally dealing with one’s finances is an unpleasant experience (or how it’s perceived). Sadly, however, keeping tabs on your finances and accounting for every cent is something you cannot avoid, at least inevitably.
The numbers on your financial dashboard paint a picture – bleak or not, about where you are and what you can achieve financially. They inform which direction or decisions to make regarding managing your finances, for example, how much debt can you take and, whether debt is the best financing option or not. How much interest are you charged? What is the repayment period?
Fortunately, you do not need to be a financial wiz to do number crunching because you can use calculators and other tools to help you, such as a loan amortisation or debt repayment and retirement calculators. However, you must know how to use and derive information from the resources to make informed decisions.
For this blog, I will discuss loan amortisation concerning taking debt because of the questions many clients have asked me in our financial wellness sessions to help them get comfortable with numbers. Examples of the questions are ‘how do I use debt optimally?’ ‘how is my instalment calculated? ‘how do I determine the cost of the loan?’ or ‘how do I get out of debt?’
What is credit?
Are you thinking of using credit to finance your car or home or access money to start or expand your business?
First things first, let us set the scene by defining what credit is and how to use it productively. Credit is the ability to borrow money at a cost to buy goods and services, with the promise of paying the money back. The cost of borrowing money is popularly known as interest which can be charged monthly, quarterly or annually. For one to access credit and use it productively, there needs to be trust that the borrower will repay the money, hence creditworthiness is important. Examples of how to use credit productively and mistakes to avoid are discussed in the blog entitled ‘How to leverage your pay slip and use debt to unlock opportunities to build wealth.
What is amortisation?
When you take out a loan to purchase a home, or car or finance personal expenses, you agree (via a finance agreement) to pay the lender i.e. bank or credit provider a monthly instalment over some time. According to Calculator.net (2004), this payment is ‘amortised’ or spread over the agreed period, where part of the payment goes towards paying off the interest portion and reducing the principal (original) amount owed.
Say, for example, you take a loan of R500 000 to purchase or build your first home and you agree to pay it back over twenty (20) years at an interest of 15.75% per annum.
How is the instalment calculated?
Using the above example and table below or a loan calculator (available online for download), you can determine the monthly instalment.
Table 1: Loan calculator
| How much is the principal or original loan amount? | R500 000 |
| What is the loan term in months?(20 years x 12 months) | 240 months |
| How much interest is charged per annum? | 15.75% |
| How much will you pay monthly? | R6 862.67 |
As aforementioned, the payment (monthly or annual) is split into two components i.e. interest payment and principal which is determined using an amortisation schedule (also known as the amortisation table).
Table two below provides a summary of the amortisation table.
| Month (period) | Payment (instalment) | Interest component | Principal payment (amount owed) | Remaining balance(Outstanding amount) |
| Opening | R500 000 | |||
| Month 1 | R6 862.67 | R6 562.50 | R300.17 | R499 699.83 |
| Month 2 | R6 862.67 | R6 558.56 | R304.11 | R499 395.72 |
| Month 3 | R6 862.67 | R6 554.57 | R308.12 | R499 087.62 |
| Month 4 | R6 862.67 | R6 550.53 | R312.14 | R498 775.48 |
| Month 5 | R6 862.67 | R6 546.53 | R316.24 | R498 459.24 |
Disclaimer: The table continues until month 240 (20 years) and is used for illustration purposes assuming interest rates do not change.
From the amortisation table above, it is evident that in the loan’s early years, a huge part of the monthly instalment goes towards paying off the interest, with little or close to nothing reducing the original amount owed. Look at month one for example, where R6 562.50 of the instalment pays off interest and only R300.17 reduces the original amount. The remaining balance is the difference between the outstanding amount and the principal amount paid e.g. R500 000 – R300.17 = R499 699.83. The longer the loan term, the more interest you will pay; should interest rates increase, the more instalment you will pay.
Why is it important to do number crunching?
When you understand your numbers, you will be empowered to make informed financial decisions such as deciding to use debt or not. As discussed in previous blog posts, there is a difference between good and bad debt, and different lines of credit are designed to address different needs, each with its advantages and disadvantages. As Benjamin Franklin once said, ‘An investment in knowledge pays the best interest,’ I encourage you to keep investing in yourself. Prioritise financial education, do thorough research, be comfortable with number crunching and seek professional advice.
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