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Why Repo Rates Matter Long Term

You may wonder why there is always such a fuss when the Resevere Bank announce a Repo Rate hike.

Why do people fixate so much on small amounts like 25 basis points and 50 basis points when it only impacts on debt repayments by a half a percent here or 2 percent there?

The reason is because small increases can really hurt over the long term.

During the Covid-19 pandemic repo rates dropped to some rather historic lows. This was exciting to people who wanted to run out and take on big debts like a car purchase or a bond. 

But over the last few years that repo rate began creeping up, and up, and…up.

Now, rates are higher than they were all the way back in 2016. This means that people who took on debt have to pay a little more each month towards the interest part of their debt.

Bonds

Those who take on debt to purchase a home are perhaps the most impacted by repo rate increases.

Why?

Well, to start with it is good to know that most people who take on a bond and pay it back over 25 or 30 years end up paying back three times the bond amount.

If you get a R500 000 bond you might pay back around +- R1.5 million

If you get a R1 500 000 bond then you will likely pay back R4.5 million.

That can surprise many people. Still, this is the way interest works. Each month a very large portion of the bond repayment is allocated to the interest portion of the loan and new interest (and fees) are added.

So, paying off a bond is a slow and steady game of 3 steps forward and 2 steps back. You pay the debt down and the bank adds in more fees and interest pushing the balance back up.

‘people who took a bond at 7% may now find themselves paying it back at 9.75%’

In recent months, .people who took a bond at 7% may now find themselves paying it back at 9.75% If the rate stays so high that will ultimately mean as much as an EXTRA R1 046 520 in interest over the next 3 decades. 

If You Can Pay A Little More

Just as interest over time can hurt, so paying a little more than you are asked to can save you a lot of money over time.

‘paying a little more than you are asked to can save you a lot of money over time’

For example, if you have a bond of R1.5 Million and are able to add an extra R100 each month towards your debt you can end up paying off your debt nearly a year and a half faster.

If you could really up your game and add an extra R500 then you could cut as much as 5 years off repaying the bond.

While it might be tempting to think well i could save the R500 each month and earn interst (that is an option with many benefits) it is hard to get a rate as good as you “get” by paying into your bond faster.

That R500 payment will save you R649 000 in interest over time. If you just hid that same amount under your mattress for years it would only add up to R150 000*

*as usual we are keeping the math simple here and ignoring interest and currency  devaluation and inflation etc

Pay More If You Can

The repo rate is important because it has a serious impact on you over the long term. 

You may not even notice at first because it may only require an extra R100 here and there. As we have seen however over time that R100 can really add up.

Now you may not even have a bond and may only be using things like credit cards and overdrafts. Many people use these products and just keep using and using them. This means that although they are short term debts they can actually go on for years and years (like by paying the minimum installment) and that means small rate increases are hurting you just as badly if you are not able to bring the balances down to R0.

This is why it is good to remember that paying a small extra amount into your debts can also have long term compounded benefits.

So, if you can find a way to skip that fast food lunch this week and rather drop the money into your bond repayment your future self will really thank you.