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Fixed interest rates: comfort worth the cost?

Your budget should be stress tested before you decide to fix the interest rate on your bond repayment.

Homeowners need to consider fixing their interest rates. In a rate hiking cycle, which Absa anticipates will increase by a cumulative 50 basis points this year and a further 75 next year, pegging your interest rate at 10% may be worth your while. But is it possible and just how difficult is the process?

Absa Home Loans property analyst Jacques du Toit says a fixed rate offering to a customer will depend on current variable rates and the bank’s expectation of interest rate movements over the various fixed-rate terms, as well as a client’s credit history with the bank.

Du Toit says that with interest rates expected to rise in the near future, fixed-rate offerings from banks may currently be above the variable mortgage rate, which will have a financial impact and which is something that a customer should keep in mind. However, a fixed rate will give peace of mind if interest rates are hiked further and eventually move above the fixed rate they contracted to at an earlier stage.

In practice, however, the Absa client can fix their rate for 12, 24, 36, 48 and 60 months on any loan amount at any of its branches.

What do they get?

  • Protection against rising interest rates,
  • regular payments with no surprises and
  • better budgeting and cash flow management, since their instalments don’t vary with interest rate fluctuations.

When their fixed-rate term expires they will automatically revert to the prevailing home loan variable rate the day after expiry. However, they can apply for a new fixed interest rate contract two days before their current fixed interest rate contract expires. If they accept the quotation, the new contract will only take effect AFTER the expiry of the old contract and at the prevailing fixed interest rate.

The deciding factor

The best way to decide whether you should fix your home loan rate is to stress test your budget, says Tommy Nel, head of credit at FNB Home Loans.

The period of time as well as the expectation in the market for potential rate increases means that, on average, fixed rates will generally be somewhat more expensive than variable rate loans.

There is also a premium for raising funds for the longer periods of time; for example a fixed rate over 60 months will be higher than a fixed rate offered for 12 months, he points out.

Stress testing your budget is simple and will give you a good idea where the breaking point is when it comes to interest rate hikes.

To do this you will need to plan your budget as normal, using bank statements rather than memory. Include contingent expenses such as funds for a car, holiday expenses or any type of non-regular expenses.

“Once you have a solid budget, you will need to ascertain each expense that is affected by a repo rate increase,” says Nel. “These include home loan debt, car debt, overdraft interest and credit card debt.

“Test how much your repayments would increase for every 1% increase in the prime rate of interest. All banks should have a loan repayment calculator which can help you. For credit card and overdraft debt you can take your average monthly balance or estimate and multiply this by 1%, 2% and so on.

“This will help you to develop a strategy on whether to consider fixed rates as you will soon see at what level of interest rate increase shortfalls begins to materialise in your budget.

“For example, if with a 1% or more increase in interest rates you start to experience financial stress, fixing your interest rate at anything up to 1% above your current variable rate would have effectively helped you in significantly reducing the risk of losing your property.”

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Alison Goldberg is the former property editor of Business Day (1985) and the Financial Mail (1991-99). In 1995 she won the Sanlam Financial Journalist of the Year Award. She has edited such titles as National Constructor and The Miner in Australia and has freelanced for The Star, The South African Jewish Report and The Jerusalem Post.

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