If you don\u2019t have a background in finance, concepts like the repo rate and prime lending rate might seem a little mysterious at first. Most of us know that they have something to do with how much interest you pay on a loan in South Africa, but how these rates are set and how they affect things isn\u2019t always so clear.<\/p>\n
\u201cWith the annual budget speech approaching, it\u2019s not unlikely that interest rates will see some future fluctuation,\u201d said Tony Clarke, MD of the Rawson Property Group. \u201cIt\u2019s a good time to get comfortable with the basic concepts so that you can appreciate how any changes might affect you.\u201d<\/p>\n
Before diving into the various rates, however, Clarke recommends taking a look at the role of the South African Reserve Bank. \u201cThey\u2019re in charge of setting the interest rates, so understanding their motivations can be helpful,\u201d he said.<\/p>\n
The SARB’s main job is to manage the currency, protect its value, and help keep the economy stable and growing. To do this, it needs to be able to influence the balance of people spending money and people saving money. The simplest way to do that is to raise or lower interest rates.<\/p>\n
\u201cHigher interest rates make borrowing money expensive,\u201d said Clarke. \u201cThat encourages people to avoid debt and discourages big investments. The result is less money circulating through the economy, which helps slow inflation and stabilise economic growth.\u201d<\/p>\n
Lower interest rates, on the other hand, make borrowing money cheaper and more accessible. \u201cThis encourages investment and can help kickstart a sluggish economy,\u201d said Clarke.<\/p>\n
Despite using commercial interest rates as a key economic tool, the Reserve Bank doesn\u2019t actually control them directly. Instead, it uses the repo rate to influence things from afar.<\/p>\n
What is the Repo Rate?<\/strong><\/p>\n \u201cThe repo rate is the interest rate commercial banks pay to borrow money from the Reserve Bank,\u201d said Clarke. \u201cAt the moment it\u2019s sitting at 6.75%.\u201d<\/p>\n By raising or lowering the repo rate, the Reserve Bank effectively makes it more or less expensive for commercial banks to borrow money. This, in turn, affects how affordably they can lend money to consumers and drives what\u2019s known as the prime lending rate.<\/p>\n What is the Prime Lending Rate?<\/strong><\/p>\n \u201cThe prime lending rate (currently 10.25%) is basically a marked-up version of the repo rate that banks use as a starting point to calculate interest rates for specific clients,\u201d said Clarke. \u201cIt covers their basic profit margin, which is then adjusted up or down based on the client\u2019s risk profile. A riskier client would get an above-prime loan, while a low-risk client could get prime or lower.\u201d<\/p>\n The reason for this, Clarke explained, is that banks need a higher profit margin to make a riskier investment worth their while. It\u2019s easier to justify lower profits on a sure thing.<\/p>\n How do they connect?<\/strong><\/p>\n Bond interest rates are almost never expressed as a single number. Rather, they\u2019re described by their relationship to prime. For example, a bank won\u2019t offer you a bond at 12% (unless you opt for a fixed-rate, which is a whole other story). They\u2019d offer you prime plus 1.75%. Why? Because those two numbers are not the same thing.<\/p>\n \u201cBond interest rates are typically linked to prime so that banks can maintain their profit margins if the Reserve Bank changes the repo rate,\u201d said Clarke. \u201cIf the repo rate goes up, prime goes up, and the amount you pay on your bond climbs. If the repo rate goes down, prime goes down, and you get to share in those savings.\u201d<\/p>\n For example, prime plus 1.75% at today\u2019s rates means 10.25% + 1.75% \u2013 an effective rate of 12% interest. If the repo rate goes up by 0.5% and the banks increase prime by 0.5% as well, that loan would still be prime plus 1.75% but would have an effective rate of 12.5% (10.75% + 1.75%).<\/p>\n How do prime and repo rates influence the property market?<\/strong><\/p>\n The higher the interest rates are, the more expensive it is for people to buy property, which means fewer buyers, less demand, and slower price growth, Rawson said.<\/p>\n And bond originator, BetterBond, highlights the impact of percentages on the property sector.<\/p>\n \u201cA lower interest rate means more affordable monthly repayments plus big savings on the total cost of your home over the lifetime of the bond. On a R1 million bond taken over 20 years, for example, an interest rate that is just 0.5% lower than the current prime rate of 10.25% will save you almost R80,000.\u201d<\/p>\n \u201cIf you\u2019re a cash buyer in these situations, you can walk away with some good deals,\u201d said Clarke, \u201cbut, generally speaking, the property market takes a knock when interest rates soar.\u201d<\/p>\n If the upcoming budget speech is positive, however, Clarke predicts that we could see investor confidence climbing and interest rates remaining on the current low level.<\/p>\n \u201cIf that\u2019s the case, buyers could look forward to more affordable financing and sellers could expect a resurgence in activity on the market,\u201d he said. \u201cIt would be a very welcome boost to what has been a tough period in property. We can only wait, and hope, and see what comes.\u201d<\/p>\n
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