As the interest rate fluctuates, you may have wondered what impact this has on your outstanding debt. How much more or how much less will you pay as a result?

We decided to see what local financial experts had to say about this. We look at how interest rates impact different kinds of debt, and why interest rates fluctuate in the first place.

Tip: Sanlam Confidence Rule #18 says: “An average life doesn’t take much planning. A good one does.” Visit your Credit Profile to see how interest-rate fluctuations can affect your credit position.

Two kinds of debt to consider

According to Ariel Eliasov, head of Credit, FNB Loans, the fluctuation of the interest rate has a different impact on different types of debt.

He explains that there are two main categories of debt that need to be considered, including debt with a fixed interest rate, and debt with an interest rate that is linked to the prime interest rate.

“If you have taken out debt with a fixed interest rate, such as is the case with some personal loans, your monthly repayments will remain unchanged. Knowing that your interest rate won’t change can go a long way in helping you budget month-to-month,” says Eliasov.

However, he says that if the interest rate of your debt is linked to the prime interest rate, the change in the repo rate will directly impact your monthly instalment.

“To illustrate, an instalment on a R1 million home loan paid back over 20 years would be R8,433.40 when the interest rate is 8%. Should the interest rate drop to 7%, the instalment reduces to R7,821.99. On the other hand, if the rate increases to 9%, the instalment would increase to R9,066.26,” says Eliasov.

Repo rate versus prime lending rate

According to Adele Barnard, a financial planner at Sanlam, it helps to know the difference between the repo rate and the prime lending rate.

“Banks borrow money from the South African Reserve Bank at the repo rate, then lend the money to clients at the prime rate,” she explains. “If the repo rate goes up, the prime rate goes up – and the opposite also applies. Higher interest rates therefore make borrowing money more expensive, while lower interest rates make it cheaper to borrow money.”

Barnard says changes to the repo rate will affect people invested in bonds and those who have borrowed money from banks.

What causes interest rates to fluctuate?

According to Eliasov, when you sign up for credit, the bank will indicate the interest rate related to your credit product.

“If this interest rate is linked to the prime interest rate, and the repo rate is changed by the South African Reserve Bank (SARB), you can expect a change in the interest rate applicable to the credit product that you hold,” says Eliasov.

“An increase in the rate will result in an increase in your monthly instalments and a decrease will lessen your monthly instalments,” he adds.

Penalties not applicable for paying more

Eliasov points out that, in terms of the National Credit Act, banks cannot charge any penalties for paying additional amounts into your loan, and the bank must reduce the interest charged to you accordingly if you do this.

He explains that a reduction in your interest rate gives you the opportunity to truly make wise money management decisions. He highlights the following ideas:

“If you are unsure, review your credit agreement to see which rate type is applicable to your loan or credit facility,” says Eliasov.

What can you do as a consumer?

Barnard says you can prepare for a high-interest-rate environment by keeping your debt to a minimum.

“Don’t be over-extended – you need to be able to service all your debt when the interest rate rises,” she explains. “For instance, you don’t want to be in a position where your vehicle is repossessed or the bank puts your house on auction.”

Barnard points out that when rates increase you should use any spare funds you have, like overtime pay or a bonus, to pay off your most expensive debt first. “Remember, a bonus is technically money you never had. The best course of action is to use your bonus to service your debt; alternatively, you can start or top up an emergency fund.”

She further suggests that, when you purchase a vehicle or property, you refrain from buying to the maximum amount for which you qualify. “If interest rates go up, make sure you can still afford your car or home, and do so comfortably,” she cautions.

“Finally, it’s very important to have an emergency fund in place, in case you need extra cash during tough economic times,” she concludes.

Tip: Sanlam Confidence Rule #20 says: “Preparation is always the best preparation.” Chat to a Credit Management Coach for FREE guidance on how you can start to get ahead of your debt.