The 100-basis point interest rate cut last week means that we have seen the prime interest rate fall from 10% to 7.75% this year. In layman’s terms since the lockdown began, we have had 2% knocked off interest rates.
There are a few smart things you can do during this time to maximise this effect.
This will come as a welcome relief to many South Africans with home loans and other debt.
Home loans and vehicle repayments.
If you can continue to meet your usual bond repayments, these rate cuts offer an excellent opportunity to reduce the term of your loan. On a R1 million mortgage over 20 years at the prime interest rate, your repayment since the start of the year has effectively fallen from R9 650 to R8 209.
Instead of pocketing that saving, if you kept your repayments at R9 650, you would pay your mortgage off 68 months earlier (nearly six years), and save R312 000 in interest and fees – assuming that the interest rate does not increase during the remainder of your mortgage.
Consider other variable loans along similar lines. If your loan is less formal, you could even try to renegotiate terms in your favour. However it may benefit you, it does show how we can use rate cuts to pay off debt without an impact on our pockets.
In terms of savings:
Pensioners and other savers, on the other hand, will be hit hard because deposit rates are linked to the government repo rate. They have effectively experienced a 28% reduction in interest earned unless they opted for a fixed interest rate over a certain period.
For example, on R100 000, if the interest rate since January fell from 8% to 5.75% today, the interest earned this year will fall from R8 000 to R5 750.
Savers need to look for other interest opportunities.
In this space we are using income type funds which also have a component of their funds in bonds (and other assets) which tend to do better than cash during of a lower interest rate cycle. For funds that are very well protected, the income fund does generate more upside and is usually a better alternative for savings deposits over 12 months or longer.
An exmaple of this is the Resolute Wealth Income fund that has averaged 9.25% from 2016 to the end of 2019 as reported by Morningstar.
The addtion of other conservitive assets, that are not cash, help to hedge the portfolio in terms of the interest rate risk and also help boost returns over the longer term, to stay well ahead of inflation.
One of the final benefits I wish to touch on with regards to income funds, is the ability to access capital. Often banks and similar institutions that offer interest baring investments normally have an extended period to gain access to higher forms of interest. Meaning you may need to stay invested in a bond or a fixed deposit for 5 or more years to get a decent return.
As an example, the Resolute Wealth income fund gives a high rate of interest and can be accessed within 5 to 7 working days in most cases.
I strongly believe that clients should rather take advantage of such structures to boost cash reserves within the business and personal spectrum because of the fairly quick turn around time. If one can plan around the short wait, then this is a very good tool for the investor.