The South African Reserve Bank (SARB) has announced an interest rate cut of 1% (100 basis points) effective from March 2020. The interest rate cut brings the repo rate down to 5,25% and the prime lending rate to 8,75%. This follows the previous cut of 0,25% that was announced three months ago in January 2020 bringing the repo rate to 6,25%. The cut in the interest rate is in response to a South African economy struggling for quite some time now. In fact, Stats SA indicated that South Africa is facing its second recession in two years. The impact of Covid-19 on individuals and businesses, specifically the proposed lock-down period of 21 days, will be phenomenal, putting the economy under severe pressure. Cutting the interest rate will certainly bring much needed relief for many households and businesses amidst the latest crises we are currently facing.
Prime Lending Rate versus Repo Rate
The prime lending rate is the rate that banks use to lend money to clients. It is currently 8,75%. Banks will offer loans and financing to low-risk clients at the prime lending rate or even a rate lower than prime, for example prime less 0,5% which means clients will effectively pay 8,25%. Banks will offer loans and financing to high-risk clients at a rate higher than the prime lending rate, for example prime plus 1,25% which means clients will effectively pay 10,0% interest. The prime lending rate is thus the base rate for borrowing money from banks. The prime lending rate is determined by the repo rate. The repo rate is the interest rate at which the banks borrow money from the Reserve Bank. Currently the repo rate is 5,25%. When the repo rate decreases the prime lending rate will decrease as well. The prime lending rate can be viewed as the repo rate with a profit margin (3,5%) added for the banks.
How much will you be saving?
The table below provides an estimation of the monthly interest saving you can expect based on a 1% cut; as well as how much you can save over a 1 year and 20 year period. On a lower outstanding loan amount the monthly savings amount might appear small, but looking at the accumulated saving over a 1 year or 20 year period, it converts into a material saving.
|Total Savings Over 1 Year||Total Savings Over 20 Years|
|R 500 000||R 4 704||R 4 387||R 318||R 3 814||R 76 270|
|R 750 000||R 7 057||R 6 580||R 477||R 5 720||R 114 406|
|R 1 000 000||R 9 409||R 8 773||R 636||R 7 627||R 152 541|
|R 1 250 000||R 11 761||R 10 966||R 794||R 9 534||R 190 676|
|R 1 500 000||R 14 113||R 13 160||R 953||R 11 441||R 228 811|
|R 1 750 000||R 16 465||R 15 353||R 1 112||R 13 347||R 266 946|
|R 2 000 000||R 18 817||R 17 546||R 1 271||R 15 254||R 305 081|
|R 3 000 000||R 28 226||R 26 319||R 1 907||R 22 881||R 457 622|
|R 4 000 000||R 37 635||R 35 093||R 2 542||R 30 508||R 610 163|
Take full advantage of the saving
Due to the financial impact the current Covid-19 crises has on economies worldwide as well as businesses and individuals, the savings will certainly put valuable money back in the pockets of households. Many households might be forced to use these savings during the following few months to release financial pressure from the impact of the coronavirus. The ideal is however to not utilize savings for expenditure. From a financial fitness perspective, savings should be used in a positive manner to reduce debt or to invest in order to improve your financial position and create wealth over time.
Utilize your savings as follows to take full advantage of the saving:
- The best option is to continue to pay the higher installment towards your debt. Your full savings amount will be allocated to reduce your outstanding capital payment on your debt resulting in paying off your debt quicker and also benefiting from further interest savings over the period.
- If you have other debt with higher interest rates than your bond for example a credit card or personal loan, you can use the savings on your bond installment to repay your shorter-term debt first. By repaying debt with the highest interest rates first, you receive a bigger benefit from savings on interest.
- The Covid-19 crisis taught us the importance of having an emergency fund. Also read this blog article to understand the financial and business lessons learned from Covid-19. If you don’t yet have an emergency fund or your emergency savings is not sufficient to cover your monthly living costs for at least 3 – 6 months, use your savings to create or top-up your emergency fund.
- If you don’t have debt or have minimal debt, use your savings to invest. Investing your savings in a tax-free savings account (TFSA), with the additional benefit of not paying tax on the investment returns, is a good option to create more wealth. The current annual limit is R36,000 – read more about the tax benefits.
- Top up your retirement annuity or starting to contribute to a retirement annuity is another great option to take full advantage of your savings.
Use your savings wisely to ultimately create wealth rather than to spend it on something else.