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What is the real interest rate and what does it mean?

The prime rate has decreased three times by 25 basis points since September 2024, bringing the current prime rate down to 11%, which is good news for homebuyers. But why is it taking so long for the market to respond?

What is the “real” interest rate?

The real interest rate is the nominal interest rate adjusted for inflation, reflecting the actual purchasing power of an investment or loan. In South Africa, the prime lending rate, currently at 11%, is linked to the repo rate (7.5%) and is a key factor in home loans. 

Here's a more detailed explanation:

  • Nominal Interest Rate:

This is the stated interest rate on a loan or investment, without accounting for inflation. In our examples we will use nominal interest rate interchangeably with the prime interest rate.

  • Real Interest Rate:

This accounts for inflation, showing the actual return on an investment or the real cost of borrowing. 

  • Inflation:

The rate at which the general level of prices for goods and services is rising, and consequently, the purchasing power of money is falling. 

  • Repo Rate:

The interest rate at which the South African Reserve Bank (SARB) lends money to commercial banks. 

  • Prime Lending Rate:

The interest rate that banks charge their most creditworthy customers, and is a benchmark for other loan rates. 

Calculation of the Real Interest Rate

You can estimate the real interest rate by subtracting the inflation rate from the nominal interest rate (e.g. at 16 March 2025, the nominal interest rate is 11% and the inflation rate is 3.2%, resulting in the real interest rate being approximately 7.8%).

Importance of Real Interest Rate

Understanding the real interest rate helps investors and borrowers make informed decisions about investments and loans, as it reflects the actual purchasing power of their money. The real interest rate tells a consumer the true cost of borrowing, or the real return on savings after accounting for the erosion of purchasing power due to inflation.

SARB’s inflation targeting strategy

South Africa officially adopted inflation targeting in February 2000. Under this framework, the central bank uses monetary policy tools, primarily controlling short-term interest rates, to maintain inflation within a specified target range. The target for South Africa is set between 3% and 6%.

Prior to this, the South African Reserve Bank (SARB) employed various other frameworks, such as exchange rate targeting and money supply targeting. The shift to inflation targeting has proven more effective, offering a more realistic alignment between the SARB’s policy tools and objectives. It has also improved transparency and accountability by providing the SARB with a clear and publicly visible goal.

Why the prime rate is still too high

In May 2022, the CPI headline inflation rose above SARB’s target range for a 13-month stretch, as the prime rate was also increased significantly during that time to 11.75%. From June 2023, CPI was within the target range for a 20-month period up until now (Mar 2025). Only in Aug 2024 was the CPI below the 4.5% target and subsequently the first interest rate cut came in Sep 2024. Since then, there have been 3 interest rate cuts of 25 basis point each, resulting in a current prime rate of 11%.

However, two of the last four CPI monthly figures have been below the target range. The latest CPI figures announced for January 2025 was 3.2%, resulting in real interest rate of 7.8%. Whilst the prime rate is decreasing, the real interest rate is still very high by comparison.

Let’s look at some stable market period stats:

Q2 2019

  • Prime rate = 10%
  • Average CPI inflation = 4.1%
  • Real interest rate = 5.9%

Q2 2007

  • Prime rate = 14%
  • Average CPI inflation = 7.4%
  • Real interest rate = 6.6%

Q2 2002

  • Prime rate = 17%
  • Average CPI inflation = 11.2%
  • Real interest rate = 5.8%

It’s great to see the SARB has finally responded to market pressures - and is giving a small form of relief reflected in their latest three decisions; but it’s clear that the real interest rate is still too high for consumers. This can be seen in the slower response of the market to the rate cuts, and in a historical context by comparison with other stable market periods.

Rates are going in the right direction, we just need it to move quicker!

Use a reputable mortgage broker

Using a mortgage broker to apply for your home loan ensures that you get the best possible deal by comparing offers from all lenders. Home loans is an extremely competitive market, and it’s important to get the best rate linked to prime possible, to be in the best position personally – whatever the macroenvironment forces decide to do!

Using a reputable broker will ensure you get more value out of this free service – including the full-scale service, professional advice, utmost confidentiality and respect with your personal information, speedy approvals and priority with banks.

Phoenix Bonds is a premium mortgage broker in South Africa, with a proven track record (check out our reviews on Google).  For expert advice and personalised service, fill in your details HERE and one of our experienced Consultants will be in touch.

Comments are closed for this post, but if you have spotted an error or have additional info that you think should be in this post, feel free to contact us.

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