Have you ever wondered where the interest rates banks give you really come from? Who determines it? Are you concerned you are not getting the best interest rates on your different forms of debt?
Interest rates aren’t just thumbsucked by the banks. Even though they have some control over what interest rate they can give you, there’s a bigger player influencing the interest rate you receive on your risk profile. It’s all controlled by the prime rate and you’ll be surprised to know why it’s so important to understand it AND care about it.
Why Interest Rates Exist
Interest rates aren’t the result of someone’s fancy way of making economies more “fun.
No one is in business to make a loss. Lenders also need to run profitable businesses. The only way they can make a profit is by charging interest on the loans they grant. Interest rates are one of the key determining factors that affect the cost of credit. The rate determines at what pace interest accumulates on the loan. Lenders apply interest rates on the loans they approve as a way to make a business income.
Interest rates also serve as a way to protect lenders against the risk of lending to customers.
Certain customers have a greater likelihood of default on payments (miss payments). Lenders charge them higher interest rates to increase the earnings on the loans they approve them.
What Is the Prime Rate?
The South African Reserve Bank (SARB) is a branch of government that has a huge effect on the economy. They determine the repo rate (amongst many other things). The repo rate is the interest rate they charge the banks of South Africa. The banks need to make a profit over and beyond the repo rate (the interest they owe to the SARB). This is why they have established and now maintain a prime rate. It’s also called a prime lending rate.
The prime rate is the interest rate banks charge their prime customers (their most creditworthy customers). At the date of writing this article, the South African prime rate is 10.00%. This means the retail banks of South Africa (banks who serve the public) will most likely charge customers more than 10.00% of interest on loans.
Why Is my Interest Rate Higher than the Prime Rate?
Whether you have a strong credit score or not. You will most likely get a lending rate higher than the prime rate. The prime rate is the base rate at which a lending agreement starts. Then based on your creditworthiness the banks may increase your interest rate to if there is a higher risk of lending to you. However, a lender can charge you less than the prime rate in situations with very low risk involved.
The majority of South Africans don’t have a strong credit score. This means it may be quite risky for banks to lend to them. The banks, therefore, charge them an interest rate much higher than the prime rate. They want to assure enough business income for the risk of lending to those customers.
Why should you care what lenders are charging you?
Uncheck interest rate environments result in many lenders and banks enjoying margins on the rates they give to consumers. This can become a feast for the lending “crows” out there and is part of the mission of Fincheck. We aim to bring people into a safer and more responsible lending environment.
This means that, yes, people still get into debt, but they are in an environment where there is marketplace accountability. With further help from tools like, MyFincheck Credit Health, consumers who use Fincheck getter information and tools to improve their credit health. It is our vision that one day, many of our consumers will have moved from being net borrowers to net investors!
Can the Prime Rate Change?
The SARB governs and regulates many aspects of the South African economy. They determine the repo and ultimately the prime rate as well. They keep an eye on the economy and change the interest rates accordingly. Why should you keep an eye on it too?
There are many forms of debt in South Africa with variable interest rates. This means the interest rate applicable to that debt changes whenever the SARB changes the prevailing interest rates in South Africa.
You must be aware of this because it will affect your debt repayments if you have forms of credit with variable interest rates. Your repayments will become more expensive when the prime rate increases. It will also become cheaper if the prime rate decreases. Use this knowledge to assist in your budgeting. It will help you to steward your finances with greater efficiency and possibly help to increase your wealth.
Keep your eyes on the financial news of South Africa. Find reliable financial news sources and stay up to date. Keep your eyes on the prime rate to understand when and why your debt repayments may change. You’ll also understand why an interest rate may seem so high if a lender offers you prime plus 11% (which currently amounts to 21%).