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How the repo rate affects your bond

Butterfly effect

If you don’t have a background in finance, concepts like the repo rate and prime lending rate might seem a little mysterious at first. Most of us know that they have something to do with how much interest you pay on a loan in South Africa, but how these rates are set and how they affect things isn’t always so clear.

“With the annual budget speech approaching, it’s not unlikely that interest rates will see some future fluctuation,” says Tony Clarke, MD of the Rawson Property Group. “It’s a good time to get comfortable with the basic concepts so that you can appreciate how any changes might affect you.”

Before diving into the various rates, however, Clarke recommends taking a look at the role of the South African Reserve Bank. “They’re in charge of setting the interest rates, so understanding their motivations can be helpful,” he says.

Meet the South African Reserve Bank

The South African Reserve Bank is the central bank in our country. Its main job is to manage our currency, protect its value, and help keep our economy stable and growing. To do this, it needs to be able to influence the balance of people spending money and people saving money. The simplest way to do that is to raise or lower interest rates.

“Higher interest rates make borrowing money expensive,” says Clarke. “That encourages people to avoid debt and discourages big investments. The result is less money circulating through the economy, which helps slow inflation and stabilise economic growth.” Lower interest rates, on the other hand, make borrowing money cheaper and more accessible which encourages investment and can help kickstart a sluggish economy.

Despite using commercial interest rates as a key economic tool, the Reserve Bank doesn’t actually control them directly. Instead, it uses the repo rate to influence things from afar.

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What is the repo rate?

The repo rate is the interest rate commercial banks pay to borrow money from the Reserve Bank. At the moment it’s sitting at 6.75%. By raising or lowering the repo rate, the Reserve Bank effectively makes it more or less expensive for commercial banks to borrow money. This, in turn, affects how affordably they can lend money to consumers and drives what’s known as the prime lending rate.

What is the prime lending rate?

Interest rates on hold, for now.

The prime lending rate (currently 10.25%) is basically a marked-up version of the repo rate that banks use as a starting point to calculate interest rates for specific clients. It covers their basic profit margin, which is then adjusted up or down based on the client’s risk profile. A riskier client would get an above-prime loan, while a low-risk client could get prime or lower.

The reason for this, Clarke explains, is that banks need a higher profit margin to make a riskier investment worth their while. It’s easier to justify lower profits on a sure thing.

How do they connect?

You’ll probably have noticed that bond interest rates are almost never expressed as a single number. Rather, they’re described by their relationship to prime. For example, a bank won’t offer you a bond at 12% (unless you opt for a fixed-rate, which is a whole other story). They’d offer you prime plus 1.75%. Why? Because those two numbers are not the same thing.

“Bond interest rates are typically linked to prime so that banks can maintain their profit margins if the Reserve Bank changes the repo rate,” says Clarke. “If the repo rate goes up, prime goes up, and the amount you pay on your bond climbs. If the repo rate goes down, prime goes down, and you get to share in those savings.”

For example, prime plus 1.75% at today’s rates means 10.25% + 1.75% – an effective rate of 12% interest. If the repo rate goes up by 0.5% and the banks increase prime by 0.5% as well, that loan would still be prime plus 1.75% but would have an effective rate of 12.5% (10.75% + 1.75%).

How do prime and repo rates influence the property market?

The higher the interest rates are, the more expensive it is for people to buy property, which means fewer buyers, less demand, and slower price growth.

“If you’re a cash buyer in these situations, you can walk away with some good deals,” says Clarke, “but, generally speaking, the property market takes a knock when interest rates soar.” If the upcoming budget speech is positive, however, we could see investor confidence climbing and interest rates remaining on the current low level.

If that’s the case, buyers could look forward to more affordable financing and sellers could expect resurgence in activity on the market. It would be a very welcome boost to what has been a tough period in property.

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