THE FIXED RATE DEBATE
With the interest rate at a low that we last saw 38 years ago, it is no wonder that homeowners are contemplating fixing the interest rate on their bonds, says Adrian Goslett, CEO of RE/MAX of Southern Africa.
“A fixed interest is definitely something to think about for homeowners that are risk averse or who want to have a fixed amount that they can add into their budget every month. If a homeowner is stretched to the limit they may want to fix their rate to ensure that there are no additional or unexpected expenses that they will have to deal with over the next two years. However, there are a few aspects that homeowners should consider before deciding to fix their rate,” says Goslett.
While banks are advising home buyers to fix their rate now, which means that their monthly repayments will remain the same even if there is a rate hike in the future, generally the fixed rate is between 1.5% and 2% above the current prime rate, depending on the agreed terms of the contract. This means that the fixed rate will provide a buffer for homeowners if there is a sharp hike before the contract term is over, however, if there is no rate hike, the homeowner will be paying more for their bond than if their rate was linked to prime.
Goslett explains that at the current prime rate of 9%, repayments over a 20 year period on a bond of R500 000 would cost around R4 498.63 per month. If the rate is fixed at 11%, a bond of R500 000 would cost approximately R5 160.94 per month. For the fixed rate to have benefited the homeowner, the prime rate would need to have increased by at least 3% to 4% over the term of the rate.
Fixed-interest rate agreements are generally fixed for a period between two and five years with exceptions given by certain financial institutions. Depending on the bank or institution, in some cases the homeowner may be able to cancel the contract by giving notice, while in others the fixed rate cannot be cancelled by the homeowner until the fixed period has expired or the property is sold. Goslett warns homeowners to check what options are available to them and whether an administration fee will be charged to a fixed rate contract before signing.
Historically, interest rates have fluctuated cyclically over a five year period by approximately 5% per cycle. “However”, says Goslett, “given the current economic conditions, it is highly unlikely that the interest would increase so dramatically over the next five years and is more likely to stay fairly steady or increase marginally.”
Goslett says that the loan period is just as important as the interest rate for homeowners to take into consideration when assessing their financial future. “Homeowners could consider paying the difference between what they pay now and what they would on a fixed rate directly into the bond themselves to reduce the capital. This could also reduce the term of the loan and total interest paid over that period. In addition it would provide protection against future rate hikes or other unforeseen circumstances. A few hundred rand extra that is paid into the bond each month could save homeowners as much as R100 000 or R200 000 over the term of the loan.”
He notes that due to the fact that so many consumers have interest bearing debt, the cumulative effect of short and long term can be devastating, especially if interest rates do begin to increase. “The best way for homeowners to alleviate the stress of increasing interest rates is pay off all short-term debt as soon as possible,” Goslett concludes.