By Subash Chatrooghoon
A possible reduction in prime lending rates is expected to be announced by the Reserve Bank tomorrow, and in what is expected to be the first of several decreases, South Africans have a chance to increase savings and strengthen their personal finances, Liberty says.
Indications by economists are that a further cut in the prime lending rate could occur before the end of 2024, further boosting consumers’ disposable income or ability to save.
Interest rates have peaked for over a year
The prime lending rate was reduced to 7% during the Covid-19 pandemic to assist South Africans facing financial hardship. In November 2021, the rate began to increase, peaked at 11.75%, and has remained at this level since May 2023.
“The impact on personal incomes has been severe. But, with inflation easing and falling within the Reserve Bank’s target range, consumers have an opportunity to use the ‘rebate’ in the rate wisely instead of resuming spending.”
Significant relief on mortgage repayments
Someone with a bond with a balance of R1 million (payable over 30 years) and currently paying 11.75% interest, the bond repayment is R10 094 a month. A drop of 0.5% means this monthly payment will decrease to R9 712, saving R382 a month. Reductions in interest on short-term debt such as credit cards, car loans and bank loans will increase the cash available for household budgets.
The reduced mortgage costs offer the most significant opportunity for saving money. Keeping the monthly payment at R10 094 rather than pocketing the R382 will reduce the repayment time of a R1m bond to just over 23 years. Significant savings on interest payments will also accrue.
By doing nothing and letting current monthly repayments remain at their pre-reduction levels, savings will be made across all types of debt.
A time to save and reduce debt
Other ways to make the prime rate work to your benefit include using the opportunity to begin reducing debt. The key is stopping spending, closing unnecessary accounts, and using the newly available cash to pay off debt faster.
Also, consolidating debt with the lower rate in force could be considered. This would lower the rate charged for the consolidated debt and drop the interest costs of the individual debts in the consolidated “basket”. Savings could be considerable.
Looking further, those making financial plans covering short- and long-term goals could benefit from consulting a personal financial adviser. Considering factors like the interest rate exemption of R23 800 per annum and the tax deductions available for retirement savings could be factored into savings and retirement plans.
Extra cash paid into a retirement annuity will attract a greater rebate from the SA Revenue Service, creating a “win-win” situation by saving for your golden years.
One of the strategies often considered is opting for a fixed interest rate rather than a variable interest rate. What is chosen depends on financial goals, risk tolerance, and the economic climate.
Variable or fixed interest rate?
A variable interest rate changes periodically based on the repo rate, meaning that payments or returns alter as the interest rate changes. In a low-interest environment, variable rates might be lower than fixed rates, saving money if the rates drop. However, if rates rise, payments do the same.
With a fixed interest rate, the rate remains the same throughout a loan or investment term. Payments are, therefore, clearly defined, making budgeting and financial planning easier. However, fixed rates might be higher than the current variable rates, and if rates drop further, there are no benefits.
Perhaps the greatest opportunity a prime rate cut offers is to use savings to launch a new approach to personal finances. These include not buying expensive items like cars, appliances, or electronics on credit and buying what you need rather than what you want.
Boosting emergency funds by aiming to have three to six months’ worth of living expenses saved for emergencies such as unexpected medical bills, unemployment, or emergency car repairs can provide peace of mind.
As with all financial planning, the sooner you start, the greater the benefits. Rather than regarding this week’s rate cut as a windfall, restricting personal spending and awaiting further prime rate cuts could reduce financial pressures.
Subash Chatrooghoon is an accredited Financial Adviser at Liberty
BUSINESS REPORT