On 27 March, the South African Reserve Bank (SARB) cut interest rates by 25 basis points. Of course, this was a welcome change to South Africans, who are the most indebted in the world, according to the World Bank.

Question is, do you know how these changes will affect your loan repayments?

What are interest rates?

According to SARB Interest rates are prices for loanable funds – prices of funds invested, lent out or borrowed for various periods of time.

The institution says that interest rates are determined by the demand for and the supply of funds. If the demand for funds increases or the supply decreases, the price of funds interest rates will increase. If the demand for funds decreases or the supply increases, interest rates will drop.

“The decision to change interest rates depends on the economic environment at that time,” says Herna Morar, CEO for MMI lending. She says the Monetary Policy Committee (MPC) formally meets every two months to set and review the repo rate.

What is the repo rate and how does it affect me?

“The repurchase or repo rate is the interest rate at which the SA Reserve Bank lends money to private banks,” SARB says.

Private banks such as Capitec, ABSA, FNB and Nedbank use the Reserve Bank as the lender of the last resort when they are experiencing lack of liquidity or a cash shortfall. The Reserve Bank charges interest on the funds it metes out to the banks.  When the repo rate changes, the prime rate (interest charged by banks to their customers) changes.

“To maintain their existing profit margins, banks raise the interest rates at which they take deposits from and lend money to their customers. This causes a general rise in interest rates or the cost of holding money,” says SARB.

How do these changes in interest rates affect my loan repayments?

“When you take up an interest-bearing loan, you will pay interest on the amount which you borrow. The interest is added to your balance and accumulates until your debt has been repaid. The higher the interest rate you receive, the higher your monthly instalments will be,” explains Morar

Interest rates are tailored specifically for you, based on your credit risk profile.

If my current loan was issued at a fixed rate, will it be affected by a change in interest rates?

“If your loan has a fixed interest rate, that means it will not be affected by interest rate changes. This allows you to budget more effectively, knowing that your monthly instalments will not increase with interest rate hikes,” explains Morar.

If you have a loan which does not have a fixed interest rate, the credit provider needs to inform you when your interest rate changes.

Is there a clause in a loan contract that warns clients about the changes in interest rates?

According to Morar, loan pricing and interest rates are strictly regulated in South Africa by the National Credit Act. This legislation means that interest rates cannot exceed a maximum rate which needs to be adhered to by all credit providers. Additionally, your interest rate needs to be explicitly set out in your loan contract.

“When you take up a loan, make sure that you fully understand your loan contract and your interest rate,” Morar advises.