From May 2016, consumers can expect some relief on their loans: the government has slashed interest rates on personal loans and has simplified the formula used to calculate the maximum interest rate on loans.

Currently, the formula for calculating the maximum interest rate is the repo rate multiplied by 2.2 plus X percent, where X varies according to the type of credit agreement. This means that, whenever the repo rate goes up, the interest rate you, as a borrower, pay also rises.

However, the gap between the two increases as the repo rate is increased, because if the repo rate rises by one percentage point, the maximum interest rate rises by 2.2 percentage points.

But the government has changed the model entirely, doing away with the multiplier. The minister of trade and industry gazetted the new formula on November 6. The changes will come into effect in six months.

The new formula for calculating the maximum interest rate is the repo rate plus X, where X varies according to the type of credit agreement. For unsecured credit transactions (also known as personal loans), this is the repo rate plus 21 percent a year.

For short-term transactions, the maximum interest is five percent a month on the first loan and three percent a month on subsequent loans within a calendar year. (A short-term loan is any amount less than R8 000 and payable over not more than six months.)

This means the maximum interest that can be charged on short-term loans will be 38 percent in a calendar year, a substantial decrease from the 60 percent a year that can now be charged, based on five percent a month.

This is important for rolling loans, which are when a small loan – for example, R2 000 – is taken out and, after two or three instalments are paid, the lender offers the consumer another loan. This can result in the consumer becoming trapped in a debt spiral.

Interestingly, for development credit agreements – those for small businesses or the development of low-income housing – the maximum interest rate is the repo rate plus 27 percent a year.

In addition, the minister has gazetted maximum initiation fees and maximum service fees. The latter are capped at R60 a month.

The initiation fees for unsecured credit and short-term credit have been capped at R165 per credit agreement, plus 10 percent of the amount in excess of R1 000, but never more than R1 050.

“The new limits add stability and predictability to the monthly credit payments of lower-income consumers, who are also the most reliant on unsecured debt,” says Geordin Hill-Lewis, a Democratic Alliance Member of Parliament who is on the portfolio committee for trade and industry. “This is a victory for all credit consumers, but especially so for low-income consumers.”

Stephen Logan, the founder of Fair Credit NPC, which helps government and industry regulators to curb predatory credit practices, says he is pleased that the government has simplified the way in which the marginal interest rate is calculated. “This will help consumers. It makes it a lot simpler. It is critical from a consumer perspective to know what you are going to pay, and there should be a calculator on the National Credit Regulator’s website where each individual can work out exactly what they will pay.”

He also urges the regulator to inform the public what their monthly repayments will be after the Reserve Bank announces a change in the repo rate. “There will be some pain in the market, but interest rates do need to come down,” Logan says.

“It may mean that some businesses that have high interest rates will have to close, but it does open the space for more innovation in how lenders do business.”

Commentators have argued that if the cost of credit decreases – essentially, if interest rates, initiation and service fees fall – lenders will not earn enough money to cover write-offs or to continue doing business and will go under. As a result, the lowest income earners, who have no access to security or collateral, will be forced to turn to unscrupulous, unregistered micro-lenders.