Learn All About Interest Rates
Those of us who have not studied in the area of finance or find the subject a little confusing, may not understand key words connected to interest rates. Words like repo rate or prime lending rate, and many of us understand it might have something to do with loans and could ultimately affect us in some way. This is especially important for those who are looking to buy property or those who already have a home loan.
Let’s first have a look at the basic definition of interest rates. You will have to do some research into applying for a home loan and what all the costs involve. Those wanting to buy property generally don’t have the entire amount to hand over straight away and will therefore need the help of a bank to afford the property. After ascertaining whether you can pay the money back, the bank will loan you the money. But, you must realize that the bank will charge you interest. The bank or other lender will want to earn something from loaning out the money and the borrower is usually prepared to pay this extra amount for the opportunity to have access to a large amount of funds.
This extra amount or rate is calculated as a percentage of your total loan amount. Your risk profile will have a direct impact on the amount of interest you will pay back. The interest rates charged for things like home loans, credit cards and other loans, is generally known as the Annual Percentage Rate or APR.
You may be categorized as a high-risk applicant, because you already have a lot of debt to your name, in which case you will pay higher interest. If you are low risk, then you will pay a lower interest.
There are some factors that influence the Interest Rate:
- Inflation can have a major impact
- Policies of the Reserve Bank
- Supply and demand for credit
Obviously, you will want a lower interest rate, as this will affect the amount you pay back to the bank at the end of the month. But who controls the interest rate? The interest rate is managed by the South African Reserve Bank or SARB. Because the Reserve Bank controls the national interest rate, this influences the repo rate. By raising or lowering the interest rate, influences the amount and way people spend and save money. For example, if the Reserve Bank increases the interest rate, this will make borrowing money more expensive and many will be discouraged from taking out big loans and getting themselves into debt. This will result in less money flowing through the economy, which can help to slow down inflation as well as to steady the economic growth in the country.
Inflation is basically the amount at which prices of goods and services increases per annum. On the other hand, if there is generally an increase in the amount of money within the economy, it will result in an increase in spending and more people will be able to easily obtain a bond on their home. This is not a very good thing, as this increases consumer debt, which will ultimately have a bad outcome on the economy.
The role of the Reserve Bank:
- The bank manages the currency in South Africa
- Helps to protect the Rand value
- Responsible to help keep the country’s economy stable as well as helping it grow, by adjusting the interest rate accordingly. This aids in controlling the movement of capital in the country.
What is the Repo Interest Rate?
You have the country’s Central Bank or SARB, which loans money to the commercial banks like FNB, ABSA, Nedbank and others, at a fixed interest rate. This interest rate is what is called the Repo Rate and is also known as the Repurchase Rate. The Reserve Bank monitors the commercial Banks and what they charge the borrower or consumer. This helps to prevent the banks from loaning too much money out, which aids in countering inflation. The current Repo Rate in South Africa is 6.5%. If the Reserve Bank influences the repo rate, this will in turn affect how the bank will loan out its money to the end consumer. This then is what determines the Prime Lending Rate.
Prime Lending Rate
The banks add an extra interest rate onto the Repo Rate, which then forms the Prime Lending Rate. This is the amount the banks are prepared to loan to the consumer, you and me. This amount can change according to the national interest rate. If the national interest rate increases, then the banks must pay more to borrow the money themselves, in which case they will then raise the Prime Lending Rate. This also occurs in reverse, if the national interest rate drops, so does the Prime Lending Rate. The current Prime Lending Rate is 10%. You can view these rates at the Reserve Bank website.
Interest Rate-How it affects the Property Market
If you, as a prospective property owner can afford to pay cash for your home, then the interest rate has no effect on your transaction. However, today most South Africans that are in the process of buying property, will be relying on a loan in order to purchase their home. It is therefore very important that you understand what the interest rate means and how it will affect your loan repayments.
For prospective home owners, the prime lending rate has a considerable effect on the property market. If you own a home and have a bond, then any increase in the interest rate will cause your monthly repayments also to increase. This in turn, if it continues to rise, can result in the owner being unable to meet his monthly bond repayments and eventually lose their home. Then again, if you are applying for a bond to purchase a home and the interest rate is high or increases, then it may force you to reconsider. This means that you may have to apply for a lower bond amount, which can have two options.
One you will have to increase your deposit to fit in with the lower bond amount you are offered. Or two you will have to rethink the home you want to purchase, and may even have to buy another home that has a lower value. Another aspect that is very prevalent today is, due to the high interest rates, it may result in many prospective home buyers not even being able to afford a home bond at all. This goes to prove that the interest rate definitely has a profound effect on the property market.
The interest rate on your bond that you are offered by the bank or any financial institution when purchasing a home is dependent on the repo rate set by the South African Reserve Bank. Whenever this repo rate decreases then all home bond owners rejoice because their bond repayment will also decrease with the same percentage. However, this also applies in reverse for all those that have money invested, who will be pleased when the interest rate increases, as their investment will also then increase. This is unfortunate for many old age pensioners who have their pension invested and who are affected by the interest rate. They will suffer financially when there is a decrease in the interest rate, as their pension wills also decrease.
It is therefore in the interest of all potential home owners to try and ensure that their bond is not linked to the interest rate. This can be achieved by ensuring that the interest rate on their bond remains fixed and is not affected by the fluctuation of the interest rate. There is however a major advantage for the home owner that has a variable interest rate attached to their bond. When there is a decrease in the interest rate, the bond repayment is also reduced. The home owner then saves money and the extra money can then be used to reduce his overall bond amount. It is amazing how a little extra paid per month, towards your bond repayment, can result in a reduction of up to 5 years in the original term of the loan agreement.
How to alter the interest you are paying on your home loan
- There are a few simple things you can do, if possible, that will help to reduce the amount you repay monthly for your home loan. The most effective thing you can do, is to raise the biggest deposit you can before applying for a home loan. By doing this you can reduce your interest rate and therefore the amount you pay every month. Effectively paying off your loan faster.
- Try to decrease the term of your bond, because the longer you pay the more it is costing you. If you are struggling with repayments, then increasing your loan term might help, but over the long run, you will land up paying more.
- Every time you have some extra cash coming in, think about using this towards paying off your home loan. Again, the quicker you pay off your loan, the less you will be paying in the long run.
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