Are monthly installments better that quarterly ones?

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

18 August 2024

Karanja is planning to buy a house. A developer has made him an off-plan offer for a project expected to be completed in two years time. The houses are going for Sh7.5 million and buyers are required to make a 30 per cent deposit, that is, Sh2.25M. The balance is payable in ten quarterly instalments of 7 per cent each (Sh525,000).

With this plan, the full amount will be cleared in 30 months (one and a half years). Of course, since the house are under construction, the developer is not charging any interest. Karanja has two questions. First: would it be better to pay the monthly instalments instead of quarterly? Second: what would he lose if he waited till the project is complete and then paid the full amount at once?

Without doing any calculations, it is easy to see that the quarterly payments are better than monthly ones. If he keeps the money in a savings account, he will earn interest on the entire Sh525,000 for the three months. But he pays monthly, the full amount will only be in the account for one month only. After that, the balance will reduce and, hence, earn less.

How much less? Suppose the savings account is paying 12 per cent per annum. This comes to one per cent per month. If the Sh525,000 is saved for three months, it will earn Sh15,750.

If Karanja choses to pay monthly, then, in the first month he will get one per cent interest on Sh525,000 (Sh5,250). In the second month, there will be Sh350,000 remaining which will earn Sh3,500. Finally, the last Sh175,000 will earn Sh1,750. The total interest is Sh10,500 – almost Sh5,000 less than before.

The second question requires knowledge of the market dynamics. The Kenya Bankers Association conducts a quarterly survey of house prices based on actual amounts in mortgage contracts. In the last five years (since 2019), the average price has gone up by just 19.5 per cent! This is about 3.6 per cent per year.

Therefore, we can reasonably expect that the price of the Sh7.5M house will climb up to about Sh8M in the next two years. Keeping the money in savings can earn about Sh1.5M in the same duration. So, Karanja would be better off waiting.

However, there is also the risk that in that time, the entire project will be sold out! On the other hand, construction could also stall and never be completed resulting in complete loss of monies already paid. Is there a way of translating these two factors into numbers? That’s a story for another day.