When we talk about borrowing money, terms like the repo rate and the prime lending rate tend to come up. But what are they and how do they affect you?
JustMoney spoke to Anton Keet, programme lead for 1Life's Truth About Money to discuss the meaning of these terms and how they affect your credit agreements.
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What is the repo rate?
The repo rate is the interest rate banks pay to borrow money from the Reserve Bank, in order to extend loans to their customers. This interest is set by the Reserve’s Bank Monetary Policy Committee with the aim of regulating the inflation rate. A higher repo rate will likely decrease spending, and the prices of goods and services will be lower.
“Essentially, the higher the repo rate is, the more expensive it is for banks to borrow money. This in turn affects how affordably they can lend money to consumers, affecting what is known as the prime lending rate,” says Keet.
Currently, the repo rate in South Africa is 3.5%, and according to Keet this is the lowest it has been in decades. This situation owes to the Covid crisis and customers’ broad inability to service higher interest loans.
What is the prime lending rate?
The prime lending rate is the base interest rate that commercial banks charge their customers.
“It is what can be described as the marked-up version of the repo rate that banks use as a starting point to calculate interest rates for specific clients,” says Keet.
According to Keet, the prime lending rate covers the basic profit margin. Any further mark-up is dependent on your credit profile and the risk you pose. If you have a propensity towards bad debt, you would get an above-prime loan, while a low-risk client could get prime, or even lower.
The prime commercial bank lending is currently 7%, the lowest its been in more than four years.
How does this affect your loans?
Keet says any prime-linked credit facility that you require from banks, whether it’s a home loan, vehicle finance, or personal loan, will fluctuate with the repo and prime rates. A drop in the repo rate is a good thing for you because it means that banks will charge lower interest rates on prime rate-linked loans.
“A classic example of how banks factor this in is if we consider bond interest rates. These are almost never expressed as a single number. Instead, they are positioned in their relation to prime. For example, a bank won’t offer you a bond at 12% unless you choose the fixed rate model. Banks would often position what they offer you as prime plus 1.75%, for instance,” says Keet.
He says banks do this because they need to minimise risk and manage profit margins.
A repo rate decrease results in a drop in the prime lending rate, making longer-term purchases such as houses and cars far more affordable. According to Keet, it also increases the potential consumer spend needed to continue to drive the economy.
READ MORE: How to calculate interest on your loans
How can you prepare for changes in the rates?
According to Keet, there are two tips that can help you prepare for a potential change in interest rates.
- Financial cushion – To create a financial cushion, Keet says must take up loans that are a little less than the full amount you can afford. This will ensure that if the repo and prime rates increase, you have enough of a financial cushion to absorb the hike.
- Monitor and understand – If you are looking to make a big purchase, such as a new property, and you need to take up a loan, Keet says you need to monitor what the prime rate is. The higher the interest rates are, the more expensive it is for you to buy property, which translates to less demand, and slower price growth. People who can afford to buy for cash are in a good position to walk away with a good deal in such a situation because the property market takes a knock when interest rates soar.
There are many factors that affect the cost of taking a loan from the bank. The ideal financial situation is that you should avoid borrowing money and rather save a little every month towards your financial goals. The reality, however, is that there are some important items, like the purchase of a car or home, that you cannot finance from your pocket.
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