22 September 2016

How Do Changing Interest Rates Affect Your Pocket?

My Money Matters |

Let’s face it, when it comes to the world of finance and trying to make sense of fluctuating rates and market announcements, many of us are left in the dark. We’re constantly inundated with facts and figures that are dauntingly difficult to comprehend, and, if you’re not exactly clued up on what it all means and how it affects your personal finances, it can be rather stressful.

Our goal is to help you make sense of if it all and provide you with the information that actually affects you, in a manner that everyone can understand. So, with that in mind, we’re breaking down changing interest rates, why you should care and how it impacts your pocket. 

What is the repo rate?

The repurchase rate, commonly known as the repo rate, is the interest rate at which the central bank of a country (South African Reserve Bank, shortened to SARB, in our case) lends money to banks like Absa. The repo rate is one of the key levers used by the SARB in an attempt to control inflation (the rising cost of goods and services over time) and keep it within the three – six percent target band set by the central bank.

The repo rate is determined by numerous macro-economic factors such as South Africa’s credit rating, GDP outlook, unemployment rates and political stability. 

 How is the repo rate calculated?

The Monetary Policy Committee (MPC) is a vital part of the SARB. The committee meets for about two days, once every two months and they debate all the different local and global scenarios in order to reach a conclusion as to what is going to happen to short-term interest rates in South Africa. After the committee has reached a conclusion the repo rate, will either increase, decrease or remain the same.

The banks set the prime rate, often known simply as ‘prime’, which is the interest rate at which banks grant loans or other funds to their customers. However, for the purpose of this piece, we’ll be focusing on the repo rate.

Rising interest rates will affect you directly, both positively and negatively, as it will mean that you pay more interest on your existing debt, but the returns on your savings will increase. To put it simply, if you’ve been saving and the rates go up, it’s good news. But if you’ve been borrowing, it’s not so good.

Along with the change to the repo rate, the MPC publishes an inflation forecast, although there is no direct relationship between the forecast and monetary policy decision and the repo rate isn’t based solely on this forecast.

What does this mean for you?

Knowing if the rate is likely to increase, decrease or remain the same is very possible by analysing trends and cycles and can inform many of your financial decisions, particularly toward your debt and savings.

It’s important to realise that the repo and prime rates are intricately connected and these tend to move in cycles. The graph below clearly indicates that we were in a downward cycle from 2008 to mid-2012, where the prime rate was sitting at 8.5% and the repo rate at 5%!

Repo Graph-01

These low rates can be dangerously deceiving, as they make the prospect of taking out loans, vehicle finance etc. much more attractive, with far lower repayment rates. However, as we’ve now been in an upward cycle since 2014, with a 2% jump in the prime rate, this will have meant bad news for those that increased their debts, as they’ve seen their repayments rise year on year.

The lesson here is never to look at a rate change in isolation!

We are currently in an upward trend and another rise in the rates is very likely. As such, it’s a good idea to start focusing on repaying debts and increasing savings. Avoid increasing your debt in an upward cycle.

Let’s look at a practical example based on the following table:

Repo Table-02

If you had taken out a mortgage of R500 000 at the end of 2013, with the repayment/prime rate sitting at a very enticing 9%, you would have been paying R4499 a month in repayments. If you had then seen a 0.25% rate increase the next year, you would be paying R4579, which wouldn’t seem like a big difference. However, over the next 3 years, with the rate having risen to 10.5%, you’ll now be paying R4992 a month, which starts to take a toll on your finances.

This clearly indicates that it’s never a good idea to base your financial choices on isolated rate changes. Monitor the cycles and trends and make careful, calculated decisions. Consulting an Absa advisor for help is also highly advised before making such decisions.

What’s your next step?

A rate increase is the most likely outcome, but there’s no reason to panic or drastically change your lifestyle or spending habits. Instead keep your budget in check and focus on paying off debt and saving where you can. We’re currently on an upward cycle and the rates are likely to keep increasing for the next few years. If you can avoid borrowing money, do so, but if you can increase your savings, you can also take advantage of the positives of an increased repo rate.

For more information on the repo rate and how it impacts you personally once the announcement is made, visit your nearest Absa branch and speak to a consultant for assistance in calculating your debt repayment going forward or alternatively you could visit our site and use our online calculator.

Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.

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