Interest explained

What is interest? Interest is the fee that you are charged by a financial institution for borrowing money, charged as a percentage of the money that you have borrowed. Alternatively, it is the return that you earn from a financial institution for depositing your money with them. In both cases it is usually quoted in an annual percentage, with one twelfth of that percentage being charged each month.

Interest can also be charged by informal lenders, who will often simply state the additional amount you need to pay back each month, rather than calculating a percentage.

How does it work?
The base interest rate – or repo rate – is set by the South African Reserve Bank. This is the rate at which the Reserve Bank lends money to the commercial banks in the country. These banks then set a prime lending rate that is higher than this repo rate, and is the standard interest rate charged to customers. They may charge you more than the prime rate, depending on the level of risk they believe is involved in lending money to you. 

What does it mean for me? It’s very important to consider interest when you are borrowing money because the higher the interest rate, the more you will pay back on your loan. For example, if you borrowed R10 000 and paid it back over 12 months at a 10% interest rate, you will have paid back R10 549.92 by the end of the year. On the other hand, if you paid back the same amount of money over the same term with a 25% interest rate, you will have paid back R11 405.28. That’s a difference of R855.36.

By the same token, if you invest R1 000 at the beginning of the year at a 10% interest rate, by the end of the year you will have R1 104.71 (the interest is slightly more than 10%, thanks to compound interest).

Interest is great if it’s working in your favour – i.e. if you are earning interest on money you’ve invested. It’s not so great if it’s working against you – i.e. if you are being charged interest on the money that you’ve borrowed. It’s therefore important to remember two things:

• Always ask for a total repayment calculation on any debt that you are considering so you can see the impact of the interest you’re being charged.
• And avoid debt as far as possible and pay it off as quickly as possible, to avoid paying interest.