Nominal Interest Rates vs APR Rates

John Fuller, Principal of Chas Everitt International property, Plettenberg Bay, reports, "I read with interest the comments made by Mr CHUKA UROKO of Nigeria in the CyberProp Newsletter of 12th June regarding his comparison of interest rates in several countries, and especially his comparisons with Dubai, South Africa and the UK. It always brings a smile to my face when I hear comparisons being made about our finance rates and those of many other countries, and I have on several occasions had the pleasure of educating buyers from Europe when they have compared our mortgage rates to theirs. Most people are unaware that there is a vast difference between the calculation methods used to determine financing rates in most African and European countries compared to South Africa. As a Banker in my previous life before starting the Chas Everitt franchise in Plettenberg Bay I worked in all the English speaking African countries, plus Egypt, Mauritius, India, France, UK, and Dubai; and all these countries quoted their finance rates on a different basis to us.

South African interest rates for the financing of fixed and movable assets are quoted as Nominal Annual Compounded Monthly (NACM) Rates. Nominal Rates can be calculated and quoted for monthly, quarterly, half-yearly and annually, etc., e.g. a rate where payments are made quarterly will be quoted as NACQ. With NACM interest is calculated on a reducing balance basis, based upon the capital outstanding each month. We often hear this being referred to as the "Mortgage Redemption Method". If the NACM interest rate is 11% then interest is calculated at one twelfth of 11% per month on the balance outstanding each month. What is nice about using NACM rates is that it is easy to calculate your true cost over different periods as your interest rate stays the same regardless of the financing period. This is a particularly useful method to use where rates vary during the term of finance, or if one intends settling the transaction early.

The other countries that I have referred to use a calculation which is referred to as the 'Annual Percentage Rate yield', which is commonly called the 'APR Rate'. This is commonly used in Europe and in other countries wherever there there has been a past colonial influence in their economy. APR is calculated on a simple interest basis on the Present Value (finance amount required), and the interest cost on the PV is then simply multiplied by the number of years finance required. APR rate quotes provide a lower and often misleading interest rate percentage compared to the equivalent NACM percentage rate of interest. South Africa used APR rates until 1980, when we converted to NACM and Asset Based financiers for the first time included variable interest rate clauses in their finance agreements to cater for changes in the Prime Overdraft Rate. In fact, in those days Prime was 9,5% and our Banks were financing cars at 11,6% APR over 36 months, which was actually 21% NACM. No wonder banks are squealing today! The introduction of NACM rates created transparency and consumers have been much better off since its implementation.

If the Real Estate fraternity is made aware of the differences between the two different rate methods it will help in advising clients that our mortgage finance rates are not as ridiculously inflated as is often assumed. For example, in the Nigerian article Mr Uroko refers to an interest rate of 4%. I happen to know this will be APR, and the equivalent interest rate on an NACM rate basis over 20 years is 6,58%. It is important to remember that the quoted NACM rate always stays the same, while the APR rate varies with the finance term. For example, 4% APR over 10 years is 7.11% NACM, and over 5 years the NACM equivalent is 7,42%. Where we are also very fortunate is that few countries offer home finance over 20 and 30 years. Many go no longer than 10 years. In fact, when I retired in 2005, I was trying to introduce mortgage finance to Dubai. At that stage a home could only be leased over 10 years, with a method of passing ownership being tied to the payment of 1 Dirham thereafter. Whilst our interest rates may seem high, South Africans are fortunate to have access to generous finance terms, and our monthly repayments (monthly cash flow) is still amongst the most affordable in the World.

Therefore, next time we are in London or Paris, walk past a car showroom, take a look at the sign on the roof or windscreen. It will in all likelihood say 'Interest Only 6% APR'. As South Africans we can walk on with a smile knowing that over 60 months this rate is equivalent to 10,85% NACM, just proving that we are not so badly done by after all! Quoting APR percentages can be extremely misleading and consumers can be easily hoodwinked by the true cost of interest, especially where finance periods are not the same. For example, if finance is quoted at the same APR rate but payments are payable monthly in advance, then the nominal yield to the financier will be higher than that for monthly in arrear payments.

I hope we will all bear in mind the difference in future when we hear or read about financing rates in other countries, and ask the question - 'Is it Nominal or is it APR?' "