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Fixing your interest rate: consider the variables

Interest rate

With the interest rate currently at a 50-year low, many South Africans may consider fixing the interest rate on their home loans 

WORDS: MARANA BRAND :: PHOTOS: SHUTTERSTOCK

The dramatic 2.5% reduction in the interest rate since January 2020 has sent many borrowers running to their banks in pursuit of a fixed rather than variable interest rate on their home loans and other debts. People who fix their interest rate most likely do so in the hope of keeping their monthly repayments at the current low levels for at least the next few years even if the Reserve Bank raises rates again. A fixed rate remains unchanged even if the interest rate changes, whereas a variable rate follows the prime rate adjustments made by your bank after Reserve Bank announcements, says Old Mutual head of financial education John Manyike. An application for a home loan is by default based on a variable interest rate, according to BetterBond CEO Carl Coetzee. “Only once your bond has registered, can you apply for a fixed interest rate. The offer has a time limit, though,” Coetzee says.

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Risk and regret 

A fixed interest rate tends to be higher than a variable one because it poses more risk for the bank. A fixed interest rate is usually set for a period of up to five years, after which you would have to renegotiate it, says Coetzee. “The disadvantage of a fixed rate is that you may miss out on savings when rates are cut. On the other hand, a variable rate may be costly if the Reserve Bank maintains high interest rates over a prolonged period,” says Manyike. Adrian Goslett, regional director and CEO of REMAX of Southern Africa, strongly recommends that buyers consider the implications of fixing their interest rate to ensure they don’t regret it. “There are so many unknown variables around interest rate fluctuations that it’s impossible to tell with absolute certainty whether fixing your interest rate now will be more beneficial in the long run than if you had kept your home loan subject to interest rate changes on a variable rate,” says Goslett.

Those who choose to fix their rate should remember that they will not benefit from any further interest rate cuts for the duration of their fixed term. “Given our current economic outlook, it’s possible that interest rates will be lowered even further. Anyone who fixes their interest rate will lose out on these savings,” says Goslett. That being said, those who decide to fix their interest rate will have the peace of mind of knowing their monthly instalment will remain unchanged for the next few years, which helps with budgeting. “If this is the reason for wanting to fix your interest rates, rather leave room in your budget when applying for home finance. You will have more flexibility and save more if you choose not to fix your interest rate but rather to have reserves to pay an extra 1% to 2% on your repayments should interest rates increase during your lending term,” Goslett says.

“There are so many unknown variables around interest rate fluctuations that it’s impossible to tell with absolute certainty whether fixing your interest rate now will be more beneficial in the long run”
Adrian Goslett, regional director and CEO, REMAX of Southern Africa

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Future fluctuations 

“There are several issues with a strategy to fix your interest rate,” says RealNet MD Gerhard Kotzé. “The first is that most banks will charge borrowers a premium of between 1.5% and 3% to fix the interest rate on their bond and usually require that they do so for a period of at least two years. “The reason is, when you fix your rate, you are effectively asking the bank to take over your risk of future interest rate fluctuations. It means that if you’re currently being charged the prime rate of 7.25% on your home loan, most banks will raise the rate to at least 8.75% if you asked them now for a fixed rate for, say, the next two years. “This means on a R1m loan, for example, you’ll be paying an additional R934 per month – and you’ll effectively be ‘wasting’ that money until and unless the prime rate actually does reach 8.75% some time in the next two years.”

It’s important to understand that in this scenario the additional amount you will be paying every month will not help you shorten the term of your home loan or save you any money in the long run.“On the other hand, if you can afford the additional R934 and you use it to reduce the capital portion of your R1m bond while staying on a variable interest rate, amortisation tables show that you stand to lower the total balance outstanding to R965,000 within a year, and to R928,000 within two years compared with R952,000 without the extra payment.”

Lower balance 

If and when the interest rate rises, your minimum monthly repayment due would be calculated on a much lower capital balance, Kotzé says. “The effect of that will be that, if the interest rate does reach 8.75% in two years’ time, your minimum monthly repayment required will still be considerably less than you would have been used to paying.” In addition, he says, if you do this for two years, you will have shortened the total term of your bond by at least 12 months and cut R69,000 in interest off the total cost of your home. “Staying on a variable rate now means that you will also benefit from any further cuts the Reserve Bank may make in the coming months to try to stimulate the economy. And if you have an access-type bond, you will always be able to withdraw any additional amounts paid into your bond account should you need them in an emergency.”

“Staying on a variable rate now means that you will also benefit from any further cuts the Reserve Bank may make in the coming months to try to stimulate the economy”
Gerhard Kotzé, MD, RealNet

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