How do Interest Rates work?

How do Interest Rates work?

If you’re considering purchasing a property in South Africa, you need to understand how do interest rates. work. Interest rate is a term used to describe all the individual rates paid in the lending and borrowing exchange of the country.

The interest rate is the amount a lender charges on the principal amount and is expressed as a percentage. The lender will normally earn an income and the borrower would be willing to pay for the right to use borrowed funds.


How do Interest Rates work?

The interest rate is calculated on an annual basis, called the annual percentage rate (APR) but it can also be calculated monthly. One needs to check and verify the periods stipulated. The rate with the most effect on the interest rate is the Repo Rate. The interest rate also includes, amongst others, the Banks ‘Prime Lending Rate. Usually, banks raise their Prime Lending Rate when the South African Reserve Bank (SARB) raises the Repo Rate (the rate at which the SARB lends money to the country’s commercial banks). Thus, a decline in the Repo Rate would result in a decrease in the Prime Lending Rate.

The borrowed assets which the interest rate is charged on include money, consumer goods, vehicles and even buildings. Basically, the interest rate is the lender’s percentage of the principal amount loaned for using the assets they have in their possession over different periods of time.

Whilst interest rates are highly competitive, they are not the same. A bank will charge higher interest rates if they find the individual to be risky and there is a lower chance of that debt being repaid. As a result, banks will often give a higher interest rate to loans which are more difficult to handle such as credit cards. The higher the credit score, the lower the rate of interest you’ll pay. In the different financial markets of the world, many interest rates are set almost continuously.

Many of the best-known interest rates are for home mortgages, selling financing of instalments, borrowing overdraft, deposits and government bonds. Interest rates in an economy such as South Africa must be flexible and sensitive to changes in underlying market forces. The government’s interference in financial markets affects the price mechanism ‘s effectiveness and can easily lead to permanent damage in the flow of money.

If you borrow money and the interest rate is 5% per annum, that 5% along with the original money you borrowed will be the amount you need to repay. 

For annual interest rates, divide the interest rate by the number of payments that you will make in the year. If you make payments monthly, divide by 12 months. Multiply that by your credit balance, which will be the entire principal sum for the first charge. 

For monthly interest rates on a loan or investment, you must first determine the monthly interest rate (divide the annual interest rate by 12 months). You then divide that amount by 100.

Calculation for Interest Rates in South Africa

The following calculations are used respectively:

  • Simple interest=principal×interest rate×time
  • Compound interest=p×[(1+interest rate) n−1]

Where: p=principal and n=number of compounding periods

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