What’s Up with Interest Rates?

Oct 1, 2014 Blog  INVESTMENTS

Many despaired in July this year when Reserve Bank Governor Gill Marcus announced a repo rate hike of 25 basis points – which effectively raised the South African interest rate to 5.75%. She warned at the time that South Africa is in a rate hiking cycle and further interest rate hikes loom large on the horizon.

But is an increased interest rate necessarily such a bad thing? That fundamentally depends on what side of the coin you find yourself on.

What is Interest?

Stanlib describes interest as the price paid for the use of someone else’s money. So if you have borrowed money you will be paying interest on that money. But, if the money is yours and you keep it in a bank – specifically a high interest account – the bank pays you for the use of your money. You thus earn interest on that money. All this means is that if you are saving and investing for the future, the rate hiking cycle is good news because it means you are earning more on your money.

There is also an important difference between the nominal and the real interest rate. In a nutshell, the nominal interest rate does not take into consideration inflation while the real interest rate does. Thus if you put R10 000 away in a high savings account and you earn 5% a year on it in interest, but the inflation rate is 6% a year your real interest earned is actually minus 1% a year. If you are earning 8% a year on that R10 000 your real interest is 2%.

Real interest is therefore the nominal interest minus inflation.

Earning Interest and Peer-to-Peer Lending

There are a number of options you can take to ensure you are earning maximum real interest on your investment or savings. If you have little time or little interest you could put your money into a high savings account, money market account or unit trusts. You are then effectively handing over the decision making regarding how to invest your money to a bank or financial services company. You also pay fees for that luxury.

Another option is to invest directly through stocks, bonds and shares. This can be high reward but also high risk. It’s also a fairly time and energy expensive process, thus why so many tend to outsource this to their bank.

Another, relatively new option to South Africa, is peer-to-peer lending. Peer-to-peer lending tends to be less volatile than stock markets but allows you to decide where you are investing your money and what kind of interest you want to earn. RainFin is a peer-to-peer lending service through which you can invest your money directly into the investment opportunities you want. Or, if you are an upcoming business, it’s great opportunity to bypass the banking red tape and go straight to the investors. Through a peer-to-peer financial intermediary like RainFin, there is a little more wiggle room when it comes to interest rates.

As it stands at present the prime interest rate in South Africa is at 9%. This is what banks award in interest to borrowers with a great credit record and a promising company finances; the more risky the borrower, the higher the interest rate.

Here is the great thing about peer-to-peer lending. If you invest your money with a bank you would be lucky to earn 9% interest in a high interest account. If you borrow from a bank you would have to have your affairs in pretty good order to pay only 9% interest on that loan. Through peer-to-peer lending the borrower and lender can both get a better deal than they would otherwise, because there is no bank in the middle taking huge fees off the interest earned.

Another perk for the borrower is that the interest is not tied to the repo rate. So if Ms Marcus announces another hike in the next 12 months, your interest rate won’t increase.

Understanding interest, how it works and how to get maximum value out of it, is key to good investment. The world has changed a great deal since the days of our grandparents where the bank manager was all powerful. Today we have a number of interesting options for investment, where technology has allowed us to change the way investment works. Of course, this means you should always proceed with caution. The rule of thumb with investing is if it sounds too good to be true, it is.

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