What is an interest rate
If you are thinking of buying a home this year, it's important to keep an eye on the repo rate, says Carl Coetzee, CEO of BetterBond. "The repo rate is probably one of the most important considerations when applying for a bond, as it affects not only your monthly payments, but how much interest you will pay over the loan period. So it's important to understand what the repo rate is, how it affects the prime lending rate and why fluctuations in the repo rate will affect your monthly bond payments," says Coetzee.
The repo rate refers to the rate at which the South African Reserve Bank lends money to private banks. If the repo rate goes up, the bank's prime lending rate - which is the rate it charges customers who need to borrow money - also goes up. "This affects the amount of interest that someone who has a bank loan will have to pay. Conversely, a drop in the repo rate, and subsequent drop in the prime lending rate, will reduce the monthly bond repayment," he says. The repo rate is currently at 4%, following a 25 basis points increase last month. The Monetary Policy Committee (MPC), which decides on whether to lower, raise or hold the repo rate steady depending on inflation and other economic factors, meets six times a year. The MPC meets again in March, which presents another opportunity for a fluctuation in the repo rate.
Prime lending rate
The prime lending rate is the cost at which banks are willing to lend money to consumers. The repo rate directly impacts the prime lending rate. Banks add additional interest to the repo rate so that they can earn a margin on their loans while taking the buyer's risk profile into account. The prime lending rate is only a reference, as banks use it as a starting point when calculating a client's risk. A lower repo rate will result in a lower prime lending rate, explains Coetzee, although the actual interest payable will vary depending on a client's risk. High-risk clients may pay prime plus interest rates - slightly more than the prime lending rate of 7.5%, while lower-risk clients will benefit from concessions that will see them paying prime minus rates or less than 7.5%.
Coetzee says the prime lending rate affects your monthly bond payments and the amount of interest payable over the loan period. So for example, the monthly saving on a R2 million bond at the current prime lending rate of 7.5%, compared with the 10% it was at the start of 2020, is just over R3 100 and the interest saving over 20 years, at the current prime lending rate, is just over R765 000.
While buyers benefit from a lower repo rate, bond originators can apply to more than one bank on your behalf to secure a lower interest rate, or a rate concession. By approaching more than one bank, BetterBond is able to negotiate a better rate concession as the banks compete to offer the best deal based on the buyer's risk profile. Banks determine this risk differently, which affects the rates concession each will offer. "BetterBond's average interest rate concession when applying to and negotiating with four banks is 0.61% which, at the current prime lending rate of 7.5% could bring a buyer's interest rate down to a comfortable 6.89%. This would mean a total saving of R177 000 on a R2 million bond with a 20-year repayment period," says Coetzee.
Fixed or variable rates?
When you apply for a bond, it is by default on the basis of a variable interest rate, says Coetzee. This means that the rate at which you pay your bond will fluctuate as the repo rate changes. "Only once your bond is registered can you apply for a fixed rate, he explains." A fixed interest rate is usually higher as there is more risk for the bank, and it is usually only set for a period of up to five years. "There is no right or wrong decision when it comes to linking your bond to a fixed or variable interest rate. What is important is affordability, so make sure that you can afford the bond repayments given your financial situation and market conditions," says Coetzee.
"The repo rate is forecast to increase gradually after more than a year of record-lows, so make sure you take this into account before buying a home so that you don't overextend yourself based on what you can afford monthly," says Coetzee. Those who can afford to continue paying their bond at a higher prime lending rate, even though the repo rate is still quite low at 4%, will be able to pay off their bond even sooner.