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What are home loan interest rates and how do you pay less?

Most homeowners in South Africa require a home loan to purchase a home they want to live in, and paying interest on that loan is part of life. In this article, we unpack home loan interest and explains what it is, how the amounts that you pay are determined and how you can pay as little interest as possible when you buy a home.

What is interest?

Your interest rate is the amount of money over and above the value of your new home that you'll need to pay back to the bank. The interest rate you are offered will be expressed as a percentage – if you have a fixed-rate loan, each payment will be an equal amount. However, if you have a variable-rate loan, the payment will change periodically as the interest rate on the loan changes. Read our blog article here for more information on fixed vs variable rates.

With most home loans, you pay back a portion of the amount you borrowed (the principal) plus interest every month. Your lender will use an amortisation formula to create a payment schedule that breaks down each payment into principal and interest.

For example, let’s look at a R1 million home loan over 20 years, at 12% fixed interest:

  • Using an amortization formula, the total monthly repayment will be R11,011
    • A portion of this will be interest, and a portion will be the principal loan
    • The interest portion is much higher in the beginning, when the loan amount is higher, but gets exponentially smaller as you pay more of the principal loan amount off
    • Although the principal/interest mix changes, the monthly repayment amount will be the same for the entire 20 years

Variable rate loans work the same way, although the monthly repayment will change slightly with a change in the prime rate.

How are prime interest rates set?

This prime interest rate is based on the repo rate, which is the rate at which the South African Reserve Bank will loan money to commercial banks. Currently, the repo rate is 7.0%. The prime rate will always be higher than the repo rate. The difference between the prime lending rate and the repo rate is the amount that the banks add to ensure that they make a profit on the loans that they grant. The prime lending rates of the major banks are almost always set at 3.5% above the repo rate. It does not have to be this way but has been for over 20 years. Therefore, when the repo rate goes up or down, the prime lending rate, which in turn affects consumers directly, does too.

The repo rate is set by the Reserve Bank's Monetary Policy Committee. It gets adjusted as required to keep inflation below the target limit. In other words, the repo rate is used to keep inflation levels steady by determining how much money people have available.

How is your personalised interest rate set?

When the bank offers you a home loan, the interest rate will typically be expressed as "prime plus one" or "prime minus 0.75" to provide two examples. The "prime" referred to here is the prime interest rate which, as of November 2022, is 10.5%. Less “risky” customers will be granted prime or prime minus, while more risky customers will be given prime plus.

The specific interest rate that you are offered by the bank will depend on a number of factors - and it is likely to differ from bank to bank. Lenders will consider your credit score and payment history as well as prevailing economic conditions at the time. Generally speaking, the higher your credit score is, and the lower your loan-to-value (LTV), the better the interest rate you will be offered.

In addition to this, banks will add risk to certain clients, depending on their residency status, employment status or the type of income they earn. However, each bank perceives this risk differently which is why it is important to shop around to ensure you get the best rate for you.

How we can help you pay less

If you apply for your home loan through Phoenix Bonds, we will approach all the banks on your behalf. That means that although you only fill in one set of paperwork, your application will be submitted to all the banks. On top of this, we negotiate with the banks on your behalf to get you the best possible home loan offer. Not only can we negotiate your interest rate, but other terms as well, such as your loan amount, loan term, concession rates and attorney discounts.

We assist purchasers with credit checks, home loan prequalifications and home loan applications – up to ten different banks. Let us present you with multiple offers to ensure you get the best possible deal.

Click here to GET STARTED.

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