The repo rate as we sit here is 8.25%, and the prime rate, the rate at which banks lend money to their best customers, 11.75%. This is the highest since 2009, in the aftermath of the 2008 financial crisis.
If it was a building, your eyes would water from the wind and thin air when you stand at the top and look at the roof, that’s how high it is.
Catch those tears to wash your dishes with later, because inflation has also climbed well lately, and although there are signs of relief, it puts pressure on all of our pockets.
The thing about interest, of course, is that what you see depends on where you stand. For those of us with a mortgage or other debt, he chews us like the staff next to your drawer does the cricket ball.
If you earn interest on investments – let’s say you’re retired or something – you’re laughing all the way to the bank.
Complaining or writing about this is also nothing new: both the Bible and Church Organ have already spoken about this, and everyone in between. I would even guess that someone complained about it on a stone wall in Jerusalem in David’s days as king.
In this article, I’m going to give an overview of what interest is, why it rises, and what you can do – for both sides of the interest seesaw. Remember, see your advisor for specific advice.
(Note: I’ve written about this before. You can continue reading there for more background, but note that it’s behind a paywall.)
What is interest?
Essentially, interest is the payment received by someone who lends money to someone else. Or, viewed from the other side, it is the cost you pay to be able to borrow money.
On the one hand: if you have a cash deposit with the bank, you hopefully earn interest on it, but on the other hand, and as already mentioned, if you have debt, you pay it.
Think of it this way – you don’t work because you like your boss’ sunny personality, you do it because you have to eat and live.
Assets – stocks, property, so on – also work for income. Interest is the income that cash and bonds generate. I’m not going to go into great detail about asset classes here – that’s a post for another day and can get quite technical.
Sometimes people talk about interest, but actually refer to their rate of return. This is in the case of, for example, a unit trust with an investment house. Those underlying funds generate different types of return, which are broadly called simply interest.
Cheer or cry?
Whether you will benefit from the higher rates or not, as mentioned above, will depend on where you stand.
If you’re paying that, you’re probably already frying polony instead sirloin. If you receive it, you might be so lucky that you now drink Dom Perignon instead of box wine. (Obviously I’m exaggerating for dramatic effect here).
For people with debt – house, car, credit card – I don’t need to tell you what the impact is. You will feel it in the rising premiums on your Sandero. Depending on your home mortgage amount and the rate you got at the time, it will probably be a few thousand more.
On the other side of the coin: if you draw your income from interest-bearing investments like at least a part for most retirees, then you would have seen your income climb in the last year or so.
Of course, the longer the cycle of rising rates, the greater the impact, both ways. Interest attracts interest, that’s what we mean when we talk about compound interest.
Why is it rising?
Several books have been written on this subject, by people much smarter than me and with many degrees in economics. I’m going to try to summarize centuries of theory in concise terms, but know it’s more complex than that.
Interest rates in South Africa are for all practical purposes set by the Reserve Bank. They do this by setting the lending rate – the repo rate. This is the rate at which they lend money to banks. If the repo rate goes up, the banks’ prime rate goes up, and vice versa.
The Reserve Bank does a few things, including regulating financial institutions, managing gold reserves and issuing and destroying notes and coins. However, their overall role is to protect financial stability in South Africa.
I’m totally oversimplifying now, but higher interest rates (usually) bring down inflation. The mechanism that determines this is technical and deep.
This space is not the place for terribly technical explanations. In my experience, people’s eyes roll if you go into too much detail, except for those who are interested.
Almost like my eyes roll out loud and down the road when President Cyril tells us how the government is now really going to do something about some problem that was created by them in the first place.
Keeping inflation under control is an extremely important cornerstone of financial stability. Just ask our neighbors in Zim what happens when he goes on the run.
So when inflation gallops as it does now, the Reserve Bank raises rates to slow it down. In this analogy, it would be like putting a bigger jockey on his back just like that in the row.
So what do you do about it?
If you pull it, enjoy the increase in income. Try not to use everything – be more like the ant than the grasshopper here. Remember, the higher rates are not going to last forever.
If you pay it, you will be chipping away for a while. Prioritize your most expensive debts, and pay them off as quickly as possible. For example, credit cards are much more expensive than your home mortgage. Or: target your smallest debt, and try to pay it off as quickly as possible, then move on to the next one.
It may also make sense to consolidate certain debts – talk to your bank about this. If it’s really tight and you see trouble coming and you won’t be able to make it, go see your bank too. Now is not the time to show off your pride.
Also try to cut your costs as much as you can. If you are about to buy a house or a car, think carefully about what you are buying. There is no consensus among economists as to whether the increases are over; so plan for it not to be and factor possible increases into your budget.
Finally, and also something technical, and for a next column, but if you are retired in an ILLA product, and your income is struggling, you can consider moving to an annuity, maybe even partially. With rates as high as they are now, your annuity income should be higher than otherwise.
Here is a column about it, but very important: please go and see someone who can look at your specific situation and advise you.
- Leon-Ben is a writer, musician and financial advisor from Wellington.
- This series of columns follows from the community research of Solidarity Helping Hand. Visit Helping Hand’s website to download the full research reports.
- Also read “Most SA’ers use a third of salary for debt” on RNews.