Death of the prime rate a win for homeowners

Our group has long advocated for rate concessions that allow homebuyers to secure home loan pricing below prime.

The proposed move away from the prime lending rate (PLR), and towards the South African Reserve Bank (Sarb) policy rate (SPR) – commonly known as the repurchase (repo) rate – as the reference point for loan pricing, is a positive development that will simplify pricing and improve transparency.

Listen/read:
Why the Reserve Bank wants to ‘abolish’ the prime lending rate
No more ‘prime’ – Reserve Bank wants key rate to be used to price loans

While this reform does not automatically reduce the cost of borrowing, it does change the way interest rates are communicated by making the pricing structure more direct and easier to understand.

It also sends a strong message about the country’s commitment to financial efficiency and transparency. This will have positive implications for SA’s economic growth and sustainability.

It removes the built-in 3.5% margin reference

Historically, the prime lending rate has been set at 350 basis points above the repo rate. Under the current model, when a bank quotes a bond applicant “prime minus 1%”, the borrower is effectively paying the repo rate plus 3.5%, minus 1%.

With the proposed reform, this embedded reference margin falls away, and banks will need to be more explicit about the margin they charge above the repo rate. So instead of quoting “prime minus 1%”, they could offer “repo (currently 6.75%) plus 2.5%”, for example.

This makes it easier for homeowners to see exactly what they are paying for their bond and strengthens the ability of bond originators to negotiate better deals.

ADVERTISEMENT

CONTINUE READING BELOW

It improves transparency and encourages competition

Using the repo rate as a single reference point will make it easier for consumers to compare offers across banks. Under the current system, borrowers may assume they have a good deal when they receive a prime-linked rate, without realising that prime already includes the built-in 3.5% markup above repo.

Greater transparency should encourage more competition between banks, as margins will be more visible and directly comparable.

Listen/read:
Kganyago favours ending use of prime rate
Prime interest rate: What is it, and do we need it?
Exploring the surge in SA home loan applications

Perhaps the biggest benefit will be felt when the Reserve Bank adjusts the repo rate. Under the new approach, the impact on home loan repayments will be immediate and direct, without the need for an additional recalculation using the prime lending rate.

If the Monetary Policy Committee announces a repo rate cut to 6.25%, for example, that becomes the new base rate as soon as it takes effect.

Will the reform affect existing home loans?

Existing loan agreements will be converted into the new format without changing the effective interest rate paid by the borrower. For example, if prime is currently 10.25%, that would be reflected as repo (6.75%) plus 3.5%, ensuring that monthly repayments remain unchanged.

New contracts, however, will be structured using the repo rate as the reference rate rather than prime.

Fixed versus variable rates?

Bond applicants weighing up fixed versus variable rates should also keep in mind that variable-rate home loans will now be linked more directly to repo rate changes.

This could mean a quicker and automatic adjustment of your monthly bond payment if the repo rate is reduced. However, borrowers who prioritise payment certainty will still find value in fixing their interest rate, typically for a period of up to five years.

Long-term view

This reform aligns with global best practice and supports the Reserve Bank’s efforts to improve transparency and efficiency in South Africa’s lending market.

It also comes at a time of improving investor sentiment following South Africa’s Financial Action Task Force grey list exit and recent positive ratings developments, which together support greater confidence and long-term economic stability.

Stephan Potgieter is CEO of BetterBond.

Follow Moneyweb’s in-depth finance and business news on WhatsApp here.