Take a look at how the cut in the interest rate affects you in terms of the real interest rate, mortgage rates, capped rates and the golden rate at which you interest earned beats inflation.
REAL RATE
Don't rush out and borrow or spend more money because Reserve Bank governor, Chris Stals, has cut interest rates by one percentage point - the real cost of borrowed money remains high.
Sandra Gordon, chief economist at Syfrets, says although nominal interest rates are dropping across the board, so is the inflation rate and you must take the inflation rate into account in establishing how much you are paying for borrowed money.
To do this you must subtract the inflation rate from the interest rate you are paying. For example, the prime bank lending rate is 19,25 percent now but inflation at the end of September was eight percent (the latest figure) so the real rate of interest you now pay is 11,25 percent.
A month earlier, the prime rate was 20,25 percent and the inflation rate was 8,7 percent. The real rate you were paying was 11,55 percent.
Although the nominal interest rate of 20,25 percent has come down by one percentage point to 19,25 percent, the real rate of interest has only come down by 0,3 of a percentage point.
This figure is not entirely accurate as there is always a lag in the inflation rate coming out for the time when you are actually borrowing the money.
Gordon estimates that the actual difference will probably be about 0,5 of a percentage point lower if you were borrowing the money today.
And Gordon says you can expect real interest rates to go higher between now and January next year as the inflation rate continues to drop. It may go as low as 6,4 percent by February before creeping up again.
She does not think another drop in nominal interest rates will come before February with another one possible in May - making a total of three percentage points.
She believes Stals will base his decision on how good or bad the government has been at sticking to its budget.
By the way, as far as real interest rates go in South Africa, Gordon says, they are very much in the average range of other similar countries.
With real rates based on short-term interest rates the country at the top is Indonesia with real rates of 23,6 percent. At the bottom is Turkey with negative real interest rates of 24,2 percent. South Africa (6,2 percent) is bracketed one notch up by Greece (6,3 percent) and one notch down by Malaysia (5,9 percent).
MORTGAGE RATE
TABLE OF BENEFITS IF REPAYMENTS ARE MAINTAINED AT OLD RATE AFTER INTEREST RATE IS REDUCED
All calculations on a bond of 20 years (240 months)
The following table shows how much you will save, in rands and number of months of repayment of your bond, if you put the rand amounts shown, which you have saved after the interest rate cut, into your bond each month:
R50
R75R100R125>R150R200
On a bond of: R7500063 mths79 mths92 mths102 mths111 mths124 mths
R66533R82452R95284R104799R113468R125174
R10000052 mths67 mths9 mths89 mths97 mths>111 mths
R73562R93918R109938R123117R133305R151291
R12500045 mths59 mths70 mths79 mths87 mths100 mths
R79992R104087R122599R137422R150551R171427
R17500035 mths47 mths57 mths65 mths73 mths85 mths
R87470R116748R140843>R159604R178765R206319
R20000032 mths43 mths52 mths60 mths67 mths79 mths
R91707R122431R147124R168950R187836R219876
Source: First National Bank
CAPPED RATE
The cut in interest rates and hopes of more will come as an unwelcome surprise to at least one category of borrowers - those who bought fixed or capped rate mortgages from their banks.
A fixed interest rate is an agreement you enter into with your bank for a set length of time. The terms offered by the banks are usually 12, 18 or 24 months. For that period you accept that you will pay a set interest rate, for example, 18 percent, no matter whether official interest rates go up or down.
You would normally enter into a fixed rate mortgage if you believed that interest rates were on the way up, or at least unlikely to alter during the term of the agreement, or if you wanted certainty on the level of your repayment for the period of your fixed rate.
The fixed and capped rates on mortgages now being offered by the banks to new customers have not come down with the cut in the official interest rate and will not necessarily do so in the near future. The fixed and capped rates the banks offer are related to long-term interest rates, not short-term rates, Brad Koen, director of interest rate products at Standard Bank, said.
In South Africa in recent years long-term interest rates (the interest rates offered on government or parastatal borrowings from the private sector with a term of five years or more) have been lower than short-term rates for a number of reasons, including the need to attract foreign investors.
Fixed interest rates offered at present vary slightly from one bank to another but are currently about 17 percent for longer periods, rising to about 18 percent for a one-year contract. The rates depend also on the amount outstanding on your bond. You get a better rate for higher loan amounts.
It is common practice to charge additional finance fees if you break your fixed interest agreement. These would depend on the amount of your loan and the term it is still outstanding.
A capped rate is similar to a fixed rate. For the term of the agreement your interest rate will not go above that rate, but if the official interest rate drops, and the interest rate you would normally qualify for drops below the capped rate, the rate you will pay falls.
For example, if official interest rates are 20 percent and you would normally qualify for one percentage point below (namely 19 percent), you might feel a capped rate at 18 percent looks attractive. If the official interest rate rises to 21 percent, you will still pay 18 percent. If the official interest rate falls to 19 percent, you will still pay 18 percent. But if the official interest rate drops to 18 percent, since you would qualify for 17 percent, the interest rate you will pay drops to 17 percent.
The reason for entering into a capped rate agreement is different from entering into a fixed rate agreement. You take a capped rate contract if you expect official interest rates will fall, but are concerned that they might rise. You pay a premium for protection against rising rates. The premium is generally about 70c per R1 000 of your home loan. This premium, added to the cost of servicing the loan, can make capped rates unattractive.
GOLDEN RATE
The inflation rate has come down from 8,7 to eight percent for the year ended September, affecting the real return you can get on cash deposits or money market unit trusts.
The real rate of return on money you invest is affected not only by the inflation rate but also by tax rates.
The lower the inflation rate the better your real rate of interest. So even though interest rates came down by one percentage point the dropping inflation rate is cancelling out the effect of the lower interest rate.
To work out a real rate of return you receive on invested money you need to subtract both the inflation rate and the tax you will pay on interest from a quoted interest rate.
For example, with the inflation rate now running at eight percent, if you have a marginal tax rate of 45 percent (this clicks in when you have a taxable income of R100 000 or more) you will need to get an interest rate of more than 14,5 percent to make a real return on your investment.
The lower down the tax tables you lie, the lower the interest rate you require to get a real rate of return on your cash deposit or money market unit trusts.
The calculations in the accompanying table ignore the fact that the first R2 000 you earn in interest is tax free.
Any interest you receive above R2 000 is taxed at your full marginal rate of taxation.
The table provides marginal tax brackets with the marginal rates and the interest rate at which you will start to get a real rate of return on your money.
YOUR GOLDEN INTEREST RATE
MarginalMarginalBreakthrough
Tax BracketRatePoint
R0-30 00019% 9,9%
R30 001-R35 00030% 11,4%
R35 001-R45 00032% 11,8%
R45 001-R60 00041% 13,6%
R60 001-R70 00043% 14%
R70 001-R100 00044% 14,3%
R100 00145% 14,5%