Interest rates on overdrafts and home loans, which have just been raised by two percentage points, come in two forms - the nominal rate and the effective rate.
The nominal rate is what the bank quotes you when you borrow money. The effective rate is what you actually pay, says Johannesburg actuary, Chris Bvsenberg.
If your home loan has been upped by two percentage points to 19 percent, you will be paying an effective rate of 20,75 percent. This is because of the effect of interest on interest.
Nominal rates are based on the interest rate for a year.
With an effective rate, you are charged interest each month or each quarter. If you borrow R100 000 at 19 percent, you are charged 1,583 percent every month in interest (19 divided by 12 months). In the first month, the interest you owe will be R1 583 (R100 000 x 0,01583). This is added to the capital amount taking the total in the first month to R101 583.
In the second month, banks calculate 1,583 percent interest on the R101 583. This amounts to R1 608. After adding it to the capital amount of R101 583, you owe R103 191 after the second month and so on.