Take-home message: How interest rates affect your finances depends on whether you borrow or lend money.
There is much speculation about whether interest rates will be cut this year. But what exactly is the interest rate and how does it affect your finances?
An interest rate has a good and a bad side depending on whether you borrow or lend money. In simple terms, an interest rate is the cost of borrowing money or the return on investment for lending money.
If you take out a personal loan, you borrow money from the bank. The bank charges you a “fee” for this service. That fee is the interest. The interest is essentially the cost of using someone else’s money. Other examples are home loans, vehicle finance, credit cards, student loans, and overdrafts.
On the other hand, if you invest in a savings account at your bank, you loan your money to your bank. The bank pays you a “fee” for this service through regular interest payments determined by the interest rate. You earn interest as compensation for allowing the bank to use your money. Examples of lending money are investing in unit trusts, money-market funds, government bonds, index funds, and exchange-traded funds.
An interest rate is usually expressed as a percentage. Different products will have different interest rates. Interest rates are determined, among others, by the lender or borrower’s financial position, the duration of the loan, the country’s economy, market conditions, and government policies.
Nolwazi explains…
The interest rate for a savings account – in other words, the money you can receive from the bank – typically varies between 3,45% and 8,25%. On the other hand, the interest rate on a credit card can range from 11% to a whopping 27%! As a general rule of thumb, the interest rate to receive money is lower than the rate for borrowing money.
At the time this article was published the government’s interest rate, also called the repo rate, was 8,25 %. This is the rate at which private (sector) banks borrow rands from the South African Reserve Bank. You can find the updated repo rate here: A country’s repo rate is a benchmark for short-term interest rates in the economy. When you hear and see news reports about interest rates going up or down they usually refer to the country’s repo rate.
In short:
When you borrow money you pay interest.
When you lend money you earn interest.
Nolwazi explains…
Let’s say the repo rate is 8,25%.
Tshepo puts his bonus of R10 000 in a savings account with a fixed interest rate of 7%. In five years he earns R4 026 in interest and his investment is worth R14 026.
He takes out a home loan of R450 000 from his bank to buy a house. The bank offers him a variable interest rate of 11% over 20 years. Tshepo has to pay back R4 645 per month and the total amount he will pay over the 20 years will come to R1 114 763.
Ata wants to know…
What impact will it have on my finances if interest rates are cut?
The impact depends on whether you are a borrower or a lender ̶ you can be one or both.
For borrowers
One of the most direct impacts is a potential decrease in the interest rates on loans, which can include home loans, car loans, personal loans, and credit cards. Borrowers may find it cheaper to borrow money, leading to lower monthly payments.
For lenders
On the downside, individuals with savings accounts or other interest-bearing investments may experience a decline in interest income. Banks may offer lower interest rates on savings products, impacting the returns on these investments.
Nolwazi explains…
Remember Tshepo? Let’s say the repo rate is cut by 2% to 6,25%. His savings account won’t be affected because it has a fixed interest rate. His home loan, however, has a variable interest rate that will decrease from 11% to 9%. Tshepo now has to pay back only R4 049 per month – he will have R596 more in his pocket each month.
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