Understanding interest rates
An interest rate is a cost of borrowing money. According to Bloomberg, 80% of South Africans use debt for monthly expenses and many are unaware of how much it costs them. The real cost of borrowing robs households of about 74% of their monthly disposable income, which could be used instead of savings.
So how do interest rates work?
The South African Reserve bank sets the Repo rate, the interest rate it charges banks. Banks borrow from the SARB and set a Prime lending rate which is the lowest rate a person can get from a bank loan. A person seeking credit from the bank is given a prime lending rate and percentage depending on their credit score. The better your credit score, the lower your interest rate.
A credit score does not affect investments. The bank will offer a percentage above the repo rate as a reward for keeping your money with them. Longer investments attract higher interest rates.
Why does the Repo rate keep changing?
The cost of money, like all commodities, depends on demand and supply. Since the supply is fixed, the demand for money (by way of credit) affects the interest rate.
- Decreased interest rates:
- When people take on less debt
- When people have spending money after paying off their major expenses
- Increased interest rates:
- When people have a high demand for taking loans for a long period.
- When people struggle with affordability to pay off their loans
- When the Reserve bank expects inflation to go up
- Is meant to discourage spending and encourage saving
Since lending rates keep changing, should I fix my interest rate with the bank?
- Fixed interest rates
- Locking in an interest rate. It does not change when the Reserve Bank announces an interest rate change. Borrowers will not enjoy lower interest rates.
- Lenders tend to set this quite high, it is good when prime lending interest rates increase much higher than estimated.
- Variable interest rates
- The prime lending rate as of July 2020 was 7.25% which is good news for borrowers with variable interest rates.
- An individual’s interest rate is Prime lending + % age depending on their credit rating
How can I get the lowest rate?
Without enough savings, debt is hard to avoid. Short term debt is the easiest to access and the most expensive. Remember:
- Small amounts over a short term are expensive
- Credit card debt is cheaper than store card debt
- To keep an excellent credit score- payback in full as soon as possible
- Usually used as revolving credit- The longer you have an outstanding balance, the lower your credit score
It is worthwhile to understand interest rates to avoid overpaying for credit. One can take advantage of lower rates to make bigger and long term purchases, like a home or investment property. Avoid personal loans and store cards; rather use your credit and overdraft facilities for lower interest rates. Keep an eye on your credit score- there better your credit score the lower your interest rate.
For more information on maintaining a good credit score, contact a Met Getup coach.