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Time to stress-test your finances

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Picture: Shutterstock
Picture: Shutterstock

Johannesburg - Interest rates have increased by 100 basis points over the past three years and the prime lending interest rate has risen from 8.5% to 9.5% since 2012, which means many household budgets are becoming decidedly stretched.

To put this into perspective, for every R100 000 you borrow, you will pay an extra R1 000 a year (R83 per month). If, for example, you have a bond of R500 000, an interest rate increase from 8.5% to 9.5% will see you paying an extra R416 a month.

In July, the Reserve Bank increased interest rates by a further 0.25% and it is expected to increase rates again, as the weaker rand means higher prices for imported goods, which means higher inflation.

While, technically, we are now entering a rising interest rate cycle, economists believe we have also entered a recession.

Higher interest rates could choke any chance of an economic recovery, so a fine balance has to be found between containing imported inflation while at the same time not curbing potential economic growth.

Financial adviser Craig Gradidge of Gradidge-Mahura Investments believes this means that interest rates will climb, but the increase will be slow, and rates will go up at intervals of 0.25% at each Monetary Policy Committee meeting.

This gives consumers a bit of breathing space to review their finances to understand the impact of future rates on their budgets.

The stress test

“One way to stress-test one’s finances is to raise rates and see the impact of the higher rates on your loan repayments,” says Gradidge, who has provided the following table and information to calculate the impact of higher rates on people’s finances.

The table shows how much your income would need to increase by so that you can afford any higher loan repayments. It looks at two factors: interest rate increases and interest payments as a percentage of income.

So someone with 65% of their income being used to service debt will need to get a 14% increase in their income in order to afford higher interest payments if rates increase by 3%.

“While a 1% increase in rates seems largely manageable, increases of 3% and more could be disastrous for many. Someone with a current debt burden of 80% of income will need their income to increase by almost a third to maintain their current financial position,” says Gradidge.

He adds that, since 1976, rates have gone up by an average of 5% during an increase cycle.

In 1998, rates increased by 7% in a six-month period, resulting in financial distress and disaster for many.

If you are thinking of buying a home, make sure you have built these future rates into your affordability assessment

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