For those that follow the economical development around the country, you would have noticed the topic of the day is the reduction in the repo rate by the monetary committee of the bank of Namibia. This was met with excitement by many as lower interest rates means slightly improved disposal income. For my friends that do not really know what that mean, here is a little context on the issue.
The repo rate is that rate that allows the central banks of any country to control the flow of money in the economy. By adjusting this rate, you can either increase or decrease the “funds/money” in the economy. On the other hand, the prime rate is an index used for setting rates given for various consumer loans products. Both rates are set by the reserve bank and hence a decrease in the repo rate is likely to affect the prime lending rate.
How does this affect me and you?
Banks typically offer consumers products at a prime rate plus/minus a profit margin. This can be a fixed rate or can be a variable rate. If you are in a contract that state your interest rate is fixed, it means the bank probably did the calculation of what profit margin they want to make based on the prime rate at the time that you entered into the contract, and that will remain unchanged during the duration of the contract.
On the other hand, they could also give a variable rate loan. This means the margin is most probably fixed but the basis/ index on which that is set is likely to change. This is your typical home loan that are either set at prime plus or prime minus a % percentage.
What are the numbers? How material is the current reduction going to affect you? Looking at my home loan, I quickly punched the numbers in an amortization schedule. 25 basis points is equal to 0.25%. As such the interest that accrues on my loan will be less by 0.25% divided by 12. For me that translate into a reduction of N$79 per month and roughly N$953 per year.
What is interesting to note though is that your monthly premium is also likely to reduce because you still need to service the loan over a your original term. If the bank does not adjust the monthly repayment term, your loan will early mature. All else remaining the same, the ideal will be the monthly repayment remaining the same and your capital reducing by N$79 per year so you can finish early.
The lesson from this is that 25 basis point reduction in your annual repayment does not mean anything without contextualizing it in the bigger scheme of things. Do you think it is worth taking on additional loan or could you just cut spending N$79 somewhere so you have more money in the bank at the end of the day?
Just a thought