As a result of interest rate hikes in the past year, a homeowner with a bond of R500Â 000 is paying an extra R1Â 000 a month to his or her bank. Where does that extra mortgage payment go each month? Who benefits from the billions of extra rands that are paid by homeowners? The short answer is: the savers.
Dr Nicole Brink of the South African Reserve Bank’s financial markets department says the repo rate is the rate the Reserve Bank charges on money that the banks borrow from it through the refinancing system.
Banks do not own all the money they lend to people. They have to “borrow” it, mainly in the form of deposits from individuals or institutions, as well as from the Reserve Bank. So, when the repo rate is increased, banks also pay higher rates on their funding. Therefore, there is no net gain for banks when interest rates rise.
“In fact, the balance sheets of most banks are structured in such a way, by nature of their business, that their net interest income declines when interest rates rise and they earn more when interest rates decline,” says Brink, adding that this relationship can be extended to the economy as a whole. “When the repo rate is increased and market rates react accordingly, eventually all borrowers in the economy are penalised by having to pay higher rates on their loans, while savers are rewarded by earning higher rates on their investments.”
Higher interest rates are intended to discourage borrowing and encourage saving, which normally results in lower inflation because demand for goods and services declines as people buy less on credit, and supply increases if additional savings are used productively in the economy.
Any extra income does not go directly to the government. In fact, like any individual or corporate borrower, the government has to pay higher rates on its loans, too; for example, on the bonds and treasury bills that it issues.
The best thing to do is pay your mortgage off as fast as possible. When the interest rate cycle changes and we start to experience rate cuts, keep your bond repayments the same. Not only will you benefit from paying off your home loan faster but, should interest rates rise again, you won’t feel the pinch.