When you take out a loan, your credit provider will charge you interest on your repayments. This is essentially the monthly cost you pay to have immediate access to a lumpsum of money.
But do you know how your interest is calculated? We asked some experts about the process, and what else you should consider.
Tip: If you’re interested in taking out a personal loan, click here and fill out the form for a quote.
Working out your interest payments
According to Genaral Rukanda, head of credit management at Bayport Financial Service South Africa, interest is paid on the outstanding balance of a loan. He outlines the following calculations to determine your interest rate.
“Let’s says your outstanding balance is R100,000 in September and your quoted interest rate is 24% per annum. In order to calculate the interest, you will have to divide the annual interest rate by the number of payments you make per year,” says Rukanda.
He explains that if you make monthly payments, your rough estimate of the monthly interest rate is 24% divided by 12, which equals 2% per month.
“Since your interest is calculated on the outstanding balance, for September you will pay R2,000 towards the interest alone. This is because 2% (or 0.02) times R100,000 equals R2,000,” says Rukanda.
He adds that if your instalment is R5,000, then R2,000 of this will be the interest and R3,000 will be deducted from the outstanding capital or balance.
“After the September payment, your outstanding balance will now be R100,000 minus R3,000, which equals R97,000. In October your interest will then be 2% times R97 000, which is R1,940,” says Rukanda.
This process will then continue until your entire debt is settled. If you’re struggling to meet your monthly instalments, click here to apply to have your debt consolidated, which can lower your overall interest.
Interest is important, but it's not the only cost to consider
Rukanda says that since your interest rate is calculated on the outstanding balance, a single percentage point can increase your interest portion significantly – especially if your loan is sizeable.
“For example, a home loan of R1,000,000 at 10% means that you will pay 10% times R1,000,000, which equals R100,000 per year in total interest. If the interest rate is now 11%, then the total interest paid per year is R110,000,” says Rukanda.
Furthermore, according to Andre Van Schaik, CEO of Propell, interest is often not the only cost, and you should be aware of monthly fees or other hidden charges.
“When considering various credit options, people tend to focus on the interest rate alone. Initiation- and monthly fees often have a far more significant impact on the total cost of borrowing than an additional percentage point of interest would have had,” says van Schaik.
He points out that credit cards typically charge an initiation fee and a monthly fee which could range from R40 to R200 per month.
“Consider a credit transaction of R10,000 at 17.5% interest per annum which is repaid over 24 months. This would have a monthly instalment of R496,” says van Schaik.
“Let’s further assume an initiation fee of R180 and a monthly account fee of R40. The monthly instalment would then be R545, which translates to an effective interest rate of not 17.5% but instead 27.4%,” he explains.
When considering your credit agreements, you should always look at the proposed interest rate. But you should also consider the initiation fee and the monthly fees.
There are restrictions on interest rates
Van Schaik says that various factors determine interest rates, including the type of credit extended and the security offered by the borrower.
“The collateral for a mortgage loan is the property itself and would attract a lower interest rate than an unsecured loan, where the borrower provides no security,” says van Schaik.
He points out that the National Credit Act applies to most credit agreements and regulates the maximum interest rate for each.
Seven types of credit are listed in the act, along with their maximum interest rates, of which the following three are the most common:
- Mortgage agreements: 15.5% per year (repo rate + 12%)
- Credit facilities: 17.5% per year (repo rate + 14%)
- Unsecured credit transactions: 24.5% per year (repo rate* + 21%)
If you’re concerned your creditor is overcharging you on interest, get in touch with the National Credit Regulator and make sure that they are registered as a Financial Services Provider and are following the rules.
Reach out to your credit provider
Rukanda says that you should always contact your service provider before you go into arrears. Service providers will generally try to assist you by restructuring your loan or offering you a payment holiday.
“If the reason for not being able to pay your debt is related to death, disability, severe illness, retrenchment, or short pay, it can generally be covered by credit life cover,” says Rukanda.
If you’d like to make sure you’re getting the best deal on credit life cover, click here for a quote.