Since the arrival of Covid-19 in South Africa, the Reserve Bank has cut the repo rate three times to help our country deal with the economic impact of the pandemic. It sounds like a lot of financial jargon, but the repo rate is important to every person who has debt because it influences loan interest directly.
Let’s start with understanding the jargon. The repo rate – short for repurchase rate – is the interest rate at which the South African Reserve Bank lends money to the commercial banks so that they can extend loans to consumers.
When the repo rate changes, therefore, interest rates on bank loans also change.
The prime interest rate is the benchmark rate for a customer with a good credit record. Banks use the prime rate as a starting point when they decide on the interest rate to offer a customer. Depending on how risky or not you are as a lender, the type of loan you want, and the risk appetite of the bank, you will get offered a rate that is below or above prime. At the moment, prime is 7.25%, which is 3.5% higher than the repo rate.
Now that we know all this, it is easy to see how the interest rate on a loan from a bank will go up and down according to the repo rate – unless you have chosen a fixed interest rate when you signed your loan agreement.
But what about a personal loan from an unsecured lender like Bayport?
In answering this question, we turn our attention to the National Credit Act (NCA). The NCA determines the maximum interest rate a credit provider can charge, and this is expressed as a percentage above the repo rate.
For example, a personal loan cannot have an interest rate higher than 21% above the repo rate (24.75%), a credit card maximum is 14% above it (17.75%) and the maximum for a mortgage is 12% above (15.75%).
The interest rate on your personal loan may, therefore, change when the change in the repo rate pushes the interest on your loan above the level allowed by the NCA.
However, when the repo rate falls, your personal interest rate may or may not change, depending on the conditions of your loan agreement. If your interest rate is linked to prime, it will come down. If it is not linked to prime or the repo rate, it is likely to stay the same.
Now that we understand that interest rate changes work differently for bank loans and personal, unsecured loans, let’s consider how the two types of loans can work together when you buy a house, for instance.
Because a secured home loan from a bank comes at a lower interest rate than a personal loan, it is wise to fund your house purchase that way. However, adding additional expenses, such as transfer fees and the costs of moving into your new home, to the home loan is not a good idea. With the long-term interest you pay, these expenditures will end up costing you far more than they should.
This is where a personal loan can be very useful. You borrow the amount you need to pay for furniture removal and maybe a few other necessities like curtains or new appliances and pay it off as quickly as you can to keep the total cost of the loan as low as possible.
In this scenario, a cut in the repo rate is a great bonus for you. The instalment on your home loan will come down and you can use the extra cash in your pocket to pay off your personal loan even faster.
Conversely, when the repo rate increases, the instalment on your personal loan is unlikely to increase as well, which gives you some cash flow protection.
Talk about repo rates and prime rates is not financial jargon you can ignore. It is, in fact, the information you need to pay attention to when you plan to borrow money or already have a loan. Understanding repo and prime’s impact on loan interest is an important factor in your financial planning.
