Shaun Harris
Taking Stock
The latest, long-awaited interest rate cut should have us all ecstatic. The drop in prime and home-loan lending rates from 19% to 18% certainly seemed to please some people, typically those commentators who herald every rate cut, drop in inflation and rise in gross domestic product as the dawn of a new age of economic growth and prosperity.
But forgive us down here in the street, the average debt-laden South African citizen, for being so rude as to not share in the enthusiasm.
Sure, another 1% decline in interest rates is good news, but is it going to make much difference to our financial lives?
Well, it can, particularly if it is part of an ongoing trend of declining interest rates, and if we manage our money to get the greatest possible benefits out of lower interest.
Interest rates, though coming down, remain very high in real terms, and the large retail banks are slow to cut rates even when the repo rate, at which the banks borrow from the Reserve Bank, is nearly four percentage points lower than the prime rate.
On the other side, consumers have a government that berates the public for being a nation of poor savers, but also decrees that interest earned on savings of more than R2 000 will be fully taxable, and now even takes 25% off pension funds’ interest and rental income.
Squeezed into this private-public sector vice, the short-term options are limited.
So until the banks fall more in line with their international counterparts, and the government creates an environment where saving hard-earned money is actually worthwhile, we had better get as much benefit as we can from lower interest rates.
The 1% drop means that anybody who has borrowed money will have slightly more disposable income within the next few days or weeks.
Obviously the most sensible thing to do is to use this to repay debt more quickly, which for most people probably means maintaining home-loan and vehicle finance repayments at the same level as before.
If you share the view of a number of economists that interest rates will continue to decline, to about 16% by the end of the year and perhaps a few percentage points lower in 2000, some decisions need to be made.
Home loans is one obvious area, both for newcomers to the property market and for people holding existing bonds.
But before you change your bond, make sure switching costs don’t negate possible benefits.
Earlier this year, when home-loan rates were sitting at about 21%, all the major banks introduced some pretty innovative products offering various combinations of fixed interest or declining rates.
That’s the first choice that has to be made: do you want a variable-interest home loan that will benefit from declining interest rates, or would you rather settle for the security of fixed or declining interest on your home loan?
Obviously your view of where interest rates are heading will influence the decision, and it’s a call people have to make on their own.
The fundamentals seem to suggest interest rates should fall at least a few percentage points lower, but that was also the view just more than a year ago when rates climbed instead from 18% to 25%.
There are always possible nasties, like the rand collapsing again or events in some far- flung country dragging the South African economy down under the emerging markets label.
But if you go for declining home-loan rates, the next question is whether you want them over the shorter term (say between one and two years) or for as long as five years.
Standard Bank introduced a reducing-rate product earlier this year running over 24- months.
With the latest rate cut, the terms of the product were possibly subject to review at the time of going to press, but it seemed likely customers would be able to get a new home loan (for a bond of not less than R400 000) starting at 1% below prime and reducing by 0,5% every six months.
The Standard Bank product will probably be available over 18-months or two years.
So if you think the down trend in interest rates is temporary, take the longer option; if you want some short-term certainty but believe rates will continue to fall, go for 18-months.
Charles Chemel, deputy general manager at Standard Bank, says the question clients should ask is how much volatility they can take.
NBS still offers its interesting longer- term option, the Step Down Bond.
Also under possible review earlier this week, the product will probably start at a 1% discount to the prime rate and reduce by 0,25% every six months over a period of five years.
Divisional director at NBS, Trevor Olivier, emphasises the bank is not selling rates but rather offering clients the opportunity to “buy certainty” in an environment where interest rates cannot be predicted with certainty.
He says the bond is particularly well suited to people who want long-term security, or those who might not have the prospect of large increases in income.
Towards the end of the five-year period, the gap between falling bond repayments and rising disposable income widens dramatically – especially useful if repayments are kept at the initial amount.
This takes about eight years off the life of a 20-year bond, and also provides the comfort of spare cash that can later be accessed for an emergency.
Most home-loan products offered by the big banks have a facility to withdraw additional capital paid into the bond, which probably provides the cheapest finance available for other purchases.
Remember, any extra money put into your home loan effectively earns you interest at the prevailing home-loan rate and is not taxed. So your home can be used as the basis for financial planning.
Even with the latest reduction in the interest rates, bank overdrafts (anything up to 6% above prime), credit cards (probably higher) and hire-purchase agreements (the worst) attract high interest charges.
Rather than using one of the options above to replace the old fridge or stove, make it last for another six months and save for the purchase by putting extra money into your bond.
Once you’ve bought it, put the amount paid back into your bond over the next six months.
The car’s engine blows up in the interim, and at least you have cash you can access without paying exorbitant interest rates.
It takes a lot of self-discipline to beat high interest rates, but it’s stupid not to take advantage of lower finance costs where you can.