How to leverage the lower interest rates to pay off your debt sooner
The SA Reserve Bank’s announcement of a cut in interest rates by a further 25 basis points last month was a much-needed lifeline for consumers reeling from the effects of the Covid-19 pandemic on the economy.
This decision took the total cut this year to 300 points and lowered the repo rate to 3.5% and the prime lending rate to 10%. It also reduced the prime and base home loan rate to a historic low of 7.0%.
Neil Thompson, Head of Product and Consumer Value Proposition at African Bank, explained the world is using monetary policy to mitigate the economic fall-out of Covid-19, and South Africa has followed suit.
“Lower interest rates can improve prospects for economic growth during tough times and recession as it allows consumers to borrow more at lower interest, thereby being able to buy more and stimulate the economy.”
It is important, he says, to understand interest rates and what a lower rate means for things like debt and savings.
Let’s start with debt.
What impact does the interest rate have on your debt?
Thompson explains this depends on whether the interest rate is variable or fixed.
“If it is a fixed, the rate stays the same regardless of whether the interest rate goes up or down. Variable rates are generally linked to the prime lending rate and adjust both up and down when rates change.
“For variable rate agreements the repayment would be adjusted as rates change. If your debt is taken out over a longer term or the greater the capital amount is, the greater your savings will be if the rate decreases.”
Thompson points out that while the interest rate cut means more spending power for consumers (because current debt will be cheaper) it is not a good idea to accumulate new debt simply because the interest rate is low.
Keep these points in mind:
- Interest rates will not be low forever. Make sure before you make new debt that you can pay it back in the long term, when interest rates could return to pre-Covid-19 levels.
- If you are able to, keep up your normal repayments to creditors as this will bring down your balance faster.
- The lower interest rate may be a temptation to acquire more debt, but rather see it as an opportunity to reduce current debt.
- Clear expensive debt first. This generally includes credit cards and store cards due to their higher interest rates.
What about my savings accounts?
These will be impacted by a reduced interest rate, Thompson says.
“Savings accounts linked to the variable interest rate will reduce, which could impact your long-term financial goals. Fixed savings options like fixed deposits will not be impacted as the rates stay the same as those offered to you before the interest rate cut.”
He recommends always seeking out savings account products which offer the best possible interest rate. African Bank’s Tax Free Investment account offers an interest rate of 6.75%, for example.
“The interest rate on savings, particularly for retirement, are crucial to financial security in the future. Always ensure you understand the interest rate you are getting and that it is the best possible rate to help you grow your money,” Thompson concluded.