What is an interest rate?
Simply put, an interest rate, referred to as the cost of borrowing money, is the amount a borrower pays a lender to borrow money. Express differently, it is the compensation for a lender for the service of lending money as well as for the risk, such as default risk, pertaining to loans.
An interest rate is a percentage of the principal, which is the actual amount borrowed by an individual or business.
The intent of the article is to only focus on interest rates as they are viewed and experienced by borrowers.
Types of interest rates
In the world of finance, there are several types of interest rates, such as nominal interest rate, fixed interest rate, variable interest rate, prime interest rate, repo rate, simple interest rate, compound interest rate, and annual percentage rate (APR).
What is the nominal interest rate?
The nominal interest rate refers to the stated interest rate of a loan, indicating the actual monetary price borrowers pay lenders to use their funds. For instance, if the nominal interest rate on a loan is 7%, borrowers are required to pay seven rand (ZAR) for every hundred rand (ZAR) borrowed.
What is a fixed interest rate?
A fixed interest rate, also called a static interest rate, refers to an unchanging interest rate that is charged on a sum of money that is owed.
Features of a fixed interest rate:
- It may apply to the entire term of a loan, or for a portion of the loan term, depending on the loan agreement. Whatever the given loan term, the fixed interest rate remains the same over the set term.
- Relatively simple to calculate.
- It is not affected by changing market rates.
- The repayments for a loan remain the same for the given period.
Fixed interest rates may apply to the following types of debt: credit cards, mortgages, personal loans, student loans, and auto loans, also called vehicle loans.
Advantages of a fixed interest rate:
- The amounts of repayments (including principal repayments and interest payments) are predictable and unchangeable, allowing borrowers to plan and budget accordingly.
- A fixed interest rate protects borrowers against the risk that a loan repayment can significantly increase over time.
- It shields borrowers against sudden increases in the overnight lending rate of the central banks of countries.
- Makes it simpler to calculate the lifetime costs of loans and mortgages.
Disadvantages of a fixed interest rate
- Fixed interest rates can be higher than variable interest rates.
- Borrowers who have loans with fixed interest rates cannot benefit from declining interest rates.
- Refinancing to a lower fixed rate or changing from a fixed rate loan to a variable-rate loan can be time-consuming and costly.
Calculation of the costs of fixed interest rates
The following information is needed to calculate the costs pertaining to fixed interest rates:
- The principal amount.
- The interest rate.
- The period (term) to repay the loan.
Example:
Quinton borrows R50 000 to start a small business. The loan agreement requires him to repay the loan over 48 months at a fixed interest rate of 10% per annum. The frequency of the interest payments is annually, and the principal amount will be repaid at the end of the period of 4 years (48 months).
The annual interest payments are R5 000 (R50 000 x 10%), amounting to R15 000 (R5 000 x 3 years) for the first 36 months of the loan term. At the end of the loan term of 4 years Quinton will pay R55 000, comprising the interest payment (R5 000) of year 4 and the repayment of the principal amount (R50 000).
In total, Quinton’s fixed interest rate costs over the loan term are R20 000 (R5 000 x 4 years).
What is a variable interest rate?
A variable interest rate, also known as a floating interest rate or an adjustable interest rate, fluctuates (increasing or decreasing) over time, causing a borrower’s interest payments to change during the term of a loan.
Typically, variable interest rates are linked to a recognised benchmark interest rate, such as the prime rate in a country. (See below, ‘What is the prime rate?,’ for an explanation of the prime rate.) For instance, a floating interest rate can be expressed as ‘prime rate plus 2%.’ When the prime rate changes, the variable interest rate changes accordingly.
Floating interest rates are used most generally in mortgage loans, commonly referred to as adjustable-rate mortgages. In addition, variable rates are frequently used to calculate the costs to borrow money when credit cards, private student loans, and vehicle loans are provided by lenders.
Advantages of variable interest rates:
- Variable interest rates are generally lower than fixed interest rates, helping borrowers to reduce the overall costs of borrowing.
- A lower starting rate makes the cost to borrow money more affordable at the beginning of a loan.
- The possibility that the interest rate on a loan could decline, lowering the monthly interest payments and reducing the total repayment costs.
Disadvantages of variable interest rates:
- A lack of certainty about repayment costs, making it difficult to predict how much interest will be paid over the term of a loan.
- The possibility that the interest rate could rise, increasing the monthly interest payments as well as the total repayments costs. The interest rate may increase to a point that it may become difficult to repay a loan.
- The unpredictability of floating interest rates makes it harder for a borrower to budget for financing costs.
Calculation of the costs of variable interest rates
Let us take Quinton again as an example. The requirements in the loan agreement remain the same as with the loan on which a fixed interest rate was charged, except that the interest rate is variable at prime rate +2%.
Let us assume the prime rate will change as follows over the next four years:
| Year 1 | Year 2 | Year 3 | Year 4 |
|---|---|---|---|
| 2% | 3% | 5% | 7% |
The yearly interest payments will be calculated as follows:
- Interest in year 1: R2 000 (R50 000 x (2% + 2%))
- Interest in year 2: R2 500 (R50 000 x (3% + 2%))
- Interest in year 3: R3 500 (R50 000 x (5% + 2%))
- Interest in year 4: R4 500 (R50 000 x (7% + 2%))
The total amount of Quinton’s variable interest rate costs over the loan term of 4 years is R12 500.
At the end of year four, Quinton will pay R54 500 to the lender, comprising the principal amount of R50 000 and interest of R4 500.
What is the prime rate?
The prime rate also referred to as the prime overdraft rate or prime lending rate, is the lowest rate at which a commercial bank will lend money to its preferred and most trustworthy clients, as well as those with high credit ratings. This includes customers with a high net worth and large corporations.
The prime rate forms the underlying basis for almost all other interest rates, including rates for personal loans, loans for small businesses, mortgages, and overdrafts.
In South Africa, commercial banks link their prime rate to the repo rate (refer below under ‘What is the repo rate?’) of the South African Reserve Bank (SARB). Normally, the banks add 3.5% to the SARB’s repo rate to determine the prime overdraft rate. The mark-up basically provides their basic profit margin.
As of 6 January 2025, the current prime rate in South Africa is 7.25%, effective from 19 November 2025.
The table below shows the prime overdraft rate in South Africa since January 2016.
| Effective date | Prime rate per annum | Change in basis points | Percentage change | Number of days effective |
|---|---|---|---|---|
| 19 November 2025 | 7.25% | +25 bps | +3.57% | 483 days |
| 24 July 2025 | 7.0% | -25 bps | -3.45% | 63 days |
| 22 May 2025 | 7.25% | -50 bps | -6.45% | 37 days |
| 15 April 2025 | 7.75% | -100 bps | -11.43% | 26 days |
| 20 March 2025 | 8.75% | -100 bps | -10.26% | 63 days |
| 17 January 2025 | 9.75% | -25 bps | -2.50% | 184 days |
| 17 July 2019 | 10.0% | -25 bps | -2.44% | 236 days |
| 23 November 2018 | 10.25% | +25 bps | +2.50% | 475 days |
| 29 March 2018 | 10.0% | -25 bps | -2.44% | 251 days |
| 21 July 2017 | 10.25% | +25 bps | +2.50% | 490 days |
| 18 March 2016 | 10.0% | -25 bps | -2.44% | 49 days |
| 29 January 2016 | 10.25% |
Observations regarding the table:
- There were eleven adjustments (three upward and eight downward) to the prime rate during the given period.
- The average duration of a specific prime rate was 214.27 days.
For the period 13 June 2008 to 11 December 2008, the prime overdraft rate in South Africa was 15.50%, which is 850 basis points higher than the 7% for the period 24 July 2025 to 18 November 2025.
Example of the effect of the prime rate:
A bank in South Africa allows Claudia on 6 January 2025 a loan with a floating (variable) interest rate of prime plus 5%. The current prime overdraft rate in South Africa is 7.25%. Hence, Claudia’s loan will be charged with a simple interest rate of 12.25% (5% + 7.25%).
What is the repo rate?
The repo rate is the rate at which the central bank of a country lends money to commercial and private banks in the particular country.
In South Africa, the repo rate, short for repurchase rate, is determined by the South African Reserve Bank (SARB). The repo rate can also be described as the interest rate at which the private sector banks are allowed to borrow money from the SARB. (See the article, ‘South Africa’s Repo Rate – A Useful Guide’, for a detailed explanation of the details of the repo rate as implemented by the SARB.)
The repo rate is determined by the Monetary Policy Committee (MPC) of the SARB, ‘with the aim of achieving the SARB’s inflation-targeting mandate,’ according to the SARB’s Fact Sheet 9, ‘The South African Reserve Bank’s system of accommodation,’ referred to as SARB/FS9. (Accentuation in the citation is by the article writer.)
Currently, the Reserve Bank’s target range for inflation is 3% to 6%.
The theory is that if the SARB increases the repo rate, the banks in the private sector will increase the prime lending rate accordingly, making it more expensive and less attractive for borrowers to borrow money.
The result is a reduction in the amount of money in the country’s economy, so there is less to spend. As spending eases off, it is more difficult to increase the prices of goods and services, which helps to control inflation.
Conversely, a decrease in the repo rate, and an ensuing drop in the prime overdraft rate, will reduce the cost to borrow money. This will make more money available to spend.
An adjustment in the repo rate will consequently affect borrowers who have loans with a variable interest rate, while the interest rate of borrowers with fixed-rate loans will remain the same.
The table below indicates the adjustments in the repo rate in South Africa since January 2016.
| Month of adjustment | Repo rate before adjustment | Repo rate after adjustment | Change in basis points | Number of months since previous adjustment |
|---|---|---|---|---|
| January 2016 | 6.25% | 6.75% | + 50 bps | 2 months |
| March 2016 | 6.75% | 7.0% | + 25 bps | 2 months |
| July 2017 | 7.0% | 6.75% | - 25 bps | 16 months |
| March 2018 | 6.75% | 6.5% | - 25 bps | 8 months |
| November 2018 | 6.5% | 6.75% | + 25 bps | 8 months |
| July 2019 | 6.75% | 6.5% | - 25 bps | 8 months |
| January 2025 | 6.5% | 6.25% | - 25 bps | 6 months |
| March 2025 | 6.25% | 5.25% | - 100 bps | 2 months |
| April 2025 | 5.25% | 4.25% | - 100 bps | 1 month |
| May 2025 | 4.25% | 3.75% | - 50 bps | 1 month |
| July 2025 | 3.75% | 3.5% | - 25 bps | 2 months |
| November 2025 | 3.5% | 3.75% | + 25 bps | 16 months |
What is simple interest?
Simple interest is a basic and quick method to calculate how much interest a lender charges on a loan.
The formula to calculate simple interest is:
I = P x R x T
Where:
I = Simple interest
P = Principal amount
R = Interest rate
T = Number of periods
The period in the calculation must correspond to the term of the interest rate. For instance, if the interest is expressed as an annual rate, then the number of periods must also be indicated in years.
If the interest rate is indicated in a yearly rate, and the related period is less than a year, then the interest rate must be adjusted proportionally.
For example:
- If the interest rate is 10% per annum, but the particular calculation needs to be expressed as a quarterly interest rate, then the relevant interest rate is 2.5% (10%/4 quarters) per quarter. Hence, the 2.5% per quarter is the same as a simple interest rate of 10% per year.
- Likewise, if a loan has a simple interest rate of 8% per year, but the calculation requires a bi-annual interest rate, then the applicable interest rate is 4% (8%/2) bi-annually. Thus, the 4% interest rate for six months, equals a simple interest rate of 8% annually.
Bear in mind, changes to interest rates may sometimes be expressed in basis points (BPS). For instance, a loan’s simple interest rate is adjusted upward by 125 basis points.
The 125 BPS can be converted to a decimal. One basis point equals 0.0001 as a decimal. The conversion is executed by multiplying the 125 basis points by 0.0001 = 0.0125 in decimal terms.
To convert a basis point to a percentage, it is multiplied by 0.01% because one basis point equals 1/100th of a single percentage point. The 125 basis points are converted into a percentage by multiplying 125 BPS by 0.01% = 1.25%.
Hence, an upward adjustment of 125 BPS in the simple interest rate of a loan equals an upward change of 1.25% or 0.0125 expressed in decimal terms.
When a borrower makes a payment on a simple-interest loan, the payment is first applied to the interest of the month, and the remainder of the payment reduces the principal amount.
Simple interest rates typically apply to short-term loans and vehicle (auto) loans.
Calculation of the costs of simple interest rates
Example 1
A lender allows Doreen a loan of R20 000 for a period of 4 years and an annual interest rate of 7%.
Doreen’s simple interest expense will be calculated as follows:
Simple interest = R20 000 x 7% x 4 years.
= R5 600
Example 2
Joe receives a loan of R10 000 with the following conditions: the loan term is 1 year, and the interest rate is 5% per annum. Six months into the loan term, Joe wins the lotto, and he decides to pay back the principal amount of R10 000. This means that the period of the loan was actually 6 months, instead of 12 months.
As mentioned, if the interest rate is indicated as an annual rate, and the relevant period is less than a year, then the interest rate must be prorated for one year.
The total interest costs incurred by Joe is calculated as follows:
Simple interest = Principal amount x interest rate x number of periods
Where the annual interest rate of 5% is prorated for six months, which is 2.5% (5%/2) bi-annually.
Thus, simple interest = R10 000 x 2.5% x 1 year
= R250
What is compound interest?
Compound interest commonly referred to as ‘interest on interest,’ is also called compounding interest.
Compound interest refers to the interest that is calculated on the sum of the initial principal amount of a loan and any outstanding interest accumulated from previous periods, referred to as the account value.
Compound interest comprises four key components:
- Principal
Principal refers to the original amount borrowed by a borrower upon which the first interest payment is calculated.
- Compound interest rate
It refers to the interest rate that is paid on the account value of the loan. The interest payment for a given period equals the interest rate multiplied by the account value.
- Frequency of compounding
The compounding frequency determines how frequently the interest is calculated. For instance, monthly, quarterly, or annually.
The rate at which compound interest accumulates is based on the frequency of compounding, meaning the more the number of compounding periods, the greater the compound interest.
For instance, as illustrated below, the amount of compound interest accumulated on R1 000 compounded at 8% a year will be lower than the interest on R1 000 compounded at 4% bi-annually over the same given period.
| Amount | Interest rate | Compounding period | Interest |
|---|---|---|---|
| R1 000 | 8% | Year | R80 |
| R1 000 | 4% | Six months | R81.60* |
* R1 000 x 4% = R40 + R1 040 x 4% = R41.60
- Loan term
The loan term is the most important component of compound interest, as it essentially determines the actual cost to borrow money.
The longer the loan term, the more interest payments that can be calculated and the larger the sum of the interest will be.
Calculation of the costs of compound interest rates
Example 1
Samuel borrows R1 000 000 from a bank at a yearly compound interest rate of 8% with a loan term of 5 years.
| Year | Amount for interest calculation | Compound interest at 8 % p.a. | Amount owing at end of period (Annually) |
|---|---|---|---|
| 1 | R1 000 000 | R80 000 | R1 080 000 |
| 2 | R1 080 000 | R86 400 | R 1 166 400 |
| 3 | R1 166 400 | R93 312 | R1 259 712 |
| 4 | R 1 259 712 | R100 777 | R1 360 489 |
| 5 | R1 360 489 | R108 839 | R1 469 328 |
The compound interest for the 5 years = R469 328. Simple interest at 8% per annum would amount to R400 000 (R1 000 000 x 8% x 5 years). A difference of R69 328 over the five years.
Example 2
The same information of example 1 is used, except that the interest is compounded at 4% every six months (semi-annually), instead of 8% annually.
| Six months period | Amount for interest calculation | Compound interest at 4 % semi-annually | Amount owing at end of period (Semi-annually) |
|---|---|---|---|
| 1 | R1 000 000 | R40 000 | R1 040 000 |
| 2 | R1 040 000 | R41 600 | R 1 081 600 |
| 3 | R1 081 600 | R43 264 | R1 124 864 |
| 4 | R 1 124 864 | R44 995 | R1 169 859 |
| 5 | R1 169 859 | R46 794 | R1 216 653 |
| 6 | R1 216 653 | R48 666 | R1 265 319 |
| 7 | R1 265 319 | R50 613 | R1 315 932 |
| 8 | R1 315 932 | R52 637 | R1 368 569 |
| 9 | R1 368 569 | R54 743 | R1 423 312 |
| 10 | R1 423 312 | R56 932 | R1 480 244 |
In example 2, the compound interest for the loan term of 5 years = R480 244. An amount of R10 916 more compared to the interest cost calculated in example 1 and R80 244 more than the simple interest charges of R400 000 for the given period.
When the effect of compounding is considered, the interest rate is also referred to as the effective interest rate.
What is the annual percentage rate (APR)?
The annual percentage rate (APR) represents the yearly rate of interest a borrower is obliged to pay on a loan.
Put differently, APR determines what percentage of the principal amount of a loan a borrower will pay each year by taking the monthly payments into account.
APR is indicated as a percentage of the loan balance, providing borrowers with a useful benchmark to compare loans offered by various lenders.
The APR differs slightly from the interest rate because it includes the interest rate plus any fees, such as an admin fee and the loan processing fee, involved in procuring a loan. Although, it does not take compounding into consideration.
APR is applicable to, inter alia, mortgages, vehicle loans, and credit cards.
An APR can be fixed or variable. A fixed APR remains the same throughout the entire loan term. Contrarily, a variable APR is typically tied to a prime rate, causing it to fluctuate (rising and falling) during the term of a loan.
Frequently Asked Questions
What are the different types of interest rates?
The different types of interest rates in the world of finance incl: Prime interest rate, Nominal interest rate, Fixed and Variable interest rates, Simple interest rate, Repo rate, Annual percentage rate and Compound interest rate.
What is the prime rate now in South Africa?
As of 28 February 2025, the current prime rate in South Africa is 7.5 %
What is the 360 interest calculation?
The 360 interest calculation is generally used by Banks to calculate commercial loans to standardize daily interest rates that are based on a 30-day month.
What is an easy way to calculate interest?
Simple interest can be calculated using this formula: SI = P × R × T, where P = Principal, R = Rate of Interest, and T = Time period.
What is a floating interest rate?
A floating interest rate is also known as a variable or adjustable interest rate. The name indicates that the interest fluctuates over time, leading to an increase or decrease of payments during the loan period.
What is the Annual percentage rate?
The Annual percentage rate (APR) represents the yearly rate of interest that a borrower is obliged to pay on his/her loan.
Top 4 Brokers
