Understanding interest

You know you pay interest on what you borrow, but do you understand it? We explain what it is and how it works.


What are interest rates?

Interest rates refer to the rate at which banks allow you to borrow money from them. These rates are always calculated on the reducing balance. If you’re paying monthly instalments towards a purchase, the amount you have to pay each month is determined by the interest rate. If interest rates fall, your instalments will also drop; similarly if they rise, the amount you pay back each month will increase.


How are interest rates determined?

The South African Reserve Bank (SARB) determines a prime rate. It's the rate at which the SARB lends money to banks. The banks then charge the prime rate plus an additional percentage based on your risk profile. The National Credit Act determines the maximum rate a credit provider can charge.


Can I influence an interest rate given to me by a bank?

It depends on your credit record. If you're a higher risk because of a poor credit record, the banks and credit providers will charge a higher interest rate when they lend you money. If you have a good credit record, you may be offered a lower rate as your risk to the bank is lower. 


How can I avoid paying high interest?

Always make your payments on time. Overdrawn accounts carry interest penalties. The sooner you pay off your loan, the less interest you pay.

Shop around and compare the interest rates that different banks charge before making a decision. See if they’ll fix the interest rate you’re charged. This means your repayments will stay the same and won’t increase if the interest rate increases. Calculate the total cost of credit other banks and credit providers charge before making your decision. They often charge for credit insurance, which is added to your monthly instalment and makes it more expensive. 

Also, limit transactions that start carrying interest immediately. Examples are cash withdrawals, traveller’s cheques, and money transfers that leave your account with a debit balance.

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