Understanding interest rates as a homeowner and long-term saver

On May 30th, the South African Reserve Bank (SARB) announced its decision to keep interest rates at 8.25%. Subsequently, banks and other financial service providers will hold their prime lending rate at present levels and will review after the next SARB’s Monetary Policy Committee (MPC) meeting in July.

Angela Glover, Head of Product at FNB Home and Structured Lending says, “Most home loans in South Africa are on variable rates, as this is the standard option that is preferred by home buyers. A variable rate is linked to a base rate, usually the prime lending rate. As a home buyer, you will be offered an interest rate of either prime plus or prime minus depending on your credit score. For example, if your bank approved interest rate is prime plus 0,2%, you will be paying 11,95% interest per annum on your bond repayment.”

“Savings instruments linked to the repo rate will experience an increase in the interest earned on account of a higher variable interest rate. There will be no immediate change to those savers with fixed savings instruments. A higher repo rate results in higher income in the form of regular interest payments, which is particularly useful during bouts of market volatility and will see cash instruments becoming more attractive to South African long-term savers or investors, adds Himal Parbhoo, CEO FNB Retail Cash Investments”.

Prime is currently 11,75% and is based on the repo rate determined by SARB’s MPC. After every MPC meeting and announcement of the latest interest rate decision is shared with the public, this is when we all hear if rates remain the same, increase or decrease. Lenders are obliged to follow suit after the rate announcement has been made. So, if the repo rate goes up or down, banks will increase or decrease their lending and cash investment interest rates by the same increment. If you have a variable interest rate, your rate will also go up or down in accordance with the MPC announcement, and your interest charges will accrue at the new rate, pro rata, from the date of the change.

“An illustrative example of what that change might look like on a home loan of R1 million being paid off over 20 years: An interest rate of 11,75% requires a repayment of R10 837. If the interest rate drops by 50 basis points to 11,25%, your required repayment is R10 492. A fixed rate is not linked to prime, but rather allows you to lock in a certain interest rate for a fixed period, up to 5 years. The rate that you can lock in is dependent on South Africa’s rate cycle and the outlook of various macro economy experts on what the expectations are in the future, explains Glover”.

The benefit of a fixed rate is that you know exactly what your required instalment will be over the period of the fix, which can give a lot of comfort if you are unsure of where South Africa’s repo and prime lending rate ceiling will be in the next months or years. The disadvantage is that if you have a fixed rate and variable rates drop below your fixed rate, you are stuck on that rate until your fix expires.

Glover further highlights that “Understanding your personalised credit interest rate is a vital step in managing your monthly expenses and cash flow. Your interest rate has a real impact on your monthly repayment, as well as the total cost of credit over the life of the loan. If your interest rate is fluctuating dramatically from month to month based on complicated behavioural rules and conditions, your repayment becomes unpredictable, making it difficult to manage your budget and control your expenses”.

“Which is better? It really depends on your preference as well as where we are as a country in the rate cycle, and what the outlook is. It is worth highlighting that you can’t just choose to lock in your current lending interest rate, but rather you must get in touch with the bank and ask for a quote on what rates are available at the time. If you are interested in getting a fixed rate, you can also reach out to your bank to find out what’s on offer, and decide if it will work for you,” concludes Glover.

PERSONAL FINANCE