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Wednesday, August 17, 2022

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How rising interest rates could affect your finances

In November, and again in January and March this year, the SARB increased the interest rate by 25 basis points.

In November, and again in January and March this year, the SARB increased the interest rate by 25 basis points.

Published Jul 7, 2022

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The South African Reserve Bank’s (SARB) Monetary Policy Committee (MPC) announced a hike in the repo rate by another 50 basis points (bp) on Thursday to 4.75%, which is largely in line with analysts’ expectations. This brings the prime rate to 8.5%.

In November, and again in January and March this year, the SARB increased the interest rate by 25 basis points (bp) each – in line with the goal to restore it to a pre-pandemic level of 6.5% by the end of 2024. The decision to increase the repo rate was mostly based on the fact that the inflation rate has approached and reached the top of the inflation targeting band.

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The Reserve Bank recently hiked its forecast of headline inflation for the year to 5.9% as a result of higher fuel and food prices - and Reserve Bank Governor Lesetja Kganyago warned that risks to the inflation outlook are to the upside.

Higher rates will increase debt servicing costs

“Consumers with larger loans that are repaid over longer periods of time will see bigger increases in their loan repayments,” explains Steven Barker, Head of Everyday Banking and Cash Lending at Standard Bank. “The increased repayment will have a negative impact on household budgets, as the additional expense needs to be catered for and could lead to cutbacks in other expenditure.”

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For example, a R1 million home loan with an interest rate of 8.5% over a 20-year term will, following the rate hike, cost an additional R308 per month. Similarly, for example, the monthly instalment on a personal loan of around R100 000 over a five-year term will increase by around R30 per month.

“In an increasing interest rate environment, we expect to see consumers be more careful and considerate when taking out large loans like home loans,” Barker says.

Determine whether taking out a loan is a good idea

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Before you opt for a personal loan in the current rising interest rate environment, you'll want to consider whether there may be other, less expensive ways you could borrow to finance your needs. “Ask yourself if the loan for a desired purchase to be made can be deferred and can rather be made through savings, meaning that a smaller loan will be required,” Barker advises. In this lending climate, he suggests considering the following before taking out a loan of any nature:

  • Leave some affordability in the monthly budget to cater for some further increases in interest rates.
  • Don’t only focus on the monthly repayment of the loan, but also understand what the total cost of the loan.
  • Try reducing the length of the repayment as much as possible.

Consider debt consolidation

“Where debts can be consolidated to reduce monthly repayments, it does help households manage their monthly budgets better. If the debt consolidation can assist with reducing the overall interest this will save some money over time. The extension of the repayment term of debt through debt consolidation should be avoided as this will increase the total cost of interest over time,” Barker notes.

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Reckon with debt before investing

The best course of action in the rising interest rate environment is to manage debt first. “Consumers have debt contracts for cars, credit cards, overdrafts, term, and revolving loans where their instalments are increasing and need to ensure they can meet their debt servicing obligations. In cases where their debt repayments aren't rising, they can increase their monthly payments to keep amortising capital at the same rate instead of only servicing interest.

“Only when debt has been reduced to fall into a manageable, comfortable range and a consumer has surplus cash should they pursue investments that will offer them higher yields and an optimum risk level,” Barker concludes.

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