Factors that affect home loan interest rates

The South African Reserve Bank (SARB) is South Africa’s central bank. It is responsible for implementing our monetary policy and setting interest rates. The SARB's main aim is to achieve and maintain price stability in South Africa.

The SARB's Monetary Policy Committee (MPC) meets every two months to assess economic conditions and decide on interest rates. Every time the MPC meets to set interest rates, they look at factors like inflation, the growth of South Africa’s economy and other economies around the world. As a result, these and various other factors can impact the interest rate you are offered on a home loan. In this article we look at the different factors that can influence the interest rate, in the context of home loans.

Factor 1: Home price and loan term

The banks will look at how much money you need to buy your home and how many years it will take you to pay it off. The prime lending rate is the basic rate they use to set your interest rate. Depending on the risk, they will either add to or drop the rate for your unique financial circumstances. For example, if you are a high-risk applicant, the bank may offer you prime plus 1%. However, if you are a low-risk applicant, they could offer you prime minus 1%.

Factor 2: The size of your deposit

If you’ve saved a large deposit to put down on your home loan, the banks will see you as a low-risk applicant. This is because you will pay off a smaller amount, possibly over a shorter loan term. As a result, you will be offered a more favourable interest rate.

Factor 3: Your credit score

When you apply for a home loan or other credit, your credit score will influence your likelihood of being approved. Your credit score also plays a big role in determining the interest rate the bank will offer you. If you have a higher credit score, you will qualify for lower interest rates because you have a track record of paying back your debts on time. Lenders look for a proven history with credit to minimise their risk.

Factor 4: Inflation

The SARB uses “inflation targeting” as a method to protect our rand and control inflation. They aim to keep inflation within a target range of between 3 and 6%, which our government sets. If they protect the value of our rand, they achieve balanced and sustainable economic growth, which results in financial stability. So, when inflation increases, the MPC will increase the interest rate to slow down lending. When lending slows, inflation should slow too. 

Factor 5: The demand for money

If individual savings increase, this results in a decrease in personal spending and a decline in the demand for money. An increase in savings also usually means that there is an increase in investments. This is important for economic development, job creation and economic growth. In a nutshell, an increase in the demand for money (or credit) will raise interest rates, while a decrease in the demand for credit will decrease them.

Whether you are a first-time homebuyer or a property investor, favourable interest rates can save you a lot of money over the home loan term. Take the time to understand the factors that affect the interest rate so that you can buy your dream home with confidence, and at the right price.