The Monetary Policy Committee (MPC) of the South African Reserve Bank announced that the interest rates would be cut by 25 basis points, lowering the repo rate to 6.5% and the prime lending rate to 10%. While most of us know that this is good news, an alarming amount of us will turn a deep shade of crimson if pressed to explain why.
The good thing to hold onto if you belong to this blushing bunch is that you’re not alone in your unfamiliarity with this topic. “The announcement of the interest rate cut was a mini-triumph for all South Africans. The unfortunate reality, though, is that too few individuals fully understand exactly how this affects them, which means that they are unlikely to reap the full rewards of this decision,” says Adrian Goslett, Regional Director and CEO of RE/MAX of Southern Africa.
To begin with, the difference between the repo rate and the prime lending rate is left a mystery to most. While this distinction is unlikely to affect you directly, it is helpful to understand if you want to grasp the broader concepts. The repo rate is the rate at which the South African Reserve Bank lends money to commercial banks. These banks then add their own mark-up on this rate which results in the prime lending rate: the rate at which banks lend money to consumers. Simply put, a cut in the repo rate will mean that the interest you owe on your debt will automatically decrease. This is exactly what happened at the MPC meeting last Wednesday.
“To put this in real terms, the monthly repayment on a R1 million bond with no deposit, calculated at the new interest rate over 20 years amounts to R9,650. Based on the previous interest rate, the monthly repayment for the same bond amounted to R9,816. This totals a saving of R166 per month on bond repayments,” says Goslett.
“If you choose to channel the money you’re saving right back into your monthly bond repayment, thereby keeping the repayment at the rate before the interest cut, you can potentially cut a whole year off of your lending term.”
Of course, this all depends on how far along you are in the lifespan of your bond. If you are right at the beginning of your 20 year lending period, it is possible to shorten your lending term by up to 12 months if you choose to do as Goslett advises. But, if you are halfway through your 20 year bond, you will only be able to cut about two months off the lending term. The power of compound interest is largely to thank for this. When stretched over 20 years, this small R166 per month (plus the interest it accumulates) turns into 12 months’ worth of bond repayments. However, the amount saved when limited to just the second half of your bond lifespan, amounts to only two months’ worth of repayments. Still, two months off your total repayments amounts to a saving of close on R20,000.
“Now is also the perfect time for first-time buyers to enter the market. Their monthly repayments will be less, which in turn lowers the overall amount owed by the end of their lending term. Before the interest rate cut, a R1 million house would have ended up costing you R2,355,944 at the end of the 20 year loan period. At the current interest rate, the same house will end up costing you R2,315,664 at the end of a 20 year period. If you purchase property at the current interest rate, you are saving R40,280,” Goslett advises.
“Off the back of the interest rate cut, South Africans have the choice between two options: either enjoy the short-term pleasure of having an extra R166 to spend each month, or invest that money in a way that results in long-term financial relief,” Goslett concludes.
Issued by RE/MAX of Southern Africa