The announcement from the Monetary Policy Committee last week that the prime interest rate would remain unchanged, allowed most homeowners to breathe a sigh of relief. Homeowners have had to tighten their belts as their home loan repayments increased over the last year. This has led to many homeowners considering fixing the interest rate on their home loan.
Kay Geldenhuys, manager of property finance processing at bond originator ooba, provides some thoughts homeowners need to consider before making the decision.
When paying off a R1m home over a 20-year period, at an interest rate of 10.5%, the monthly bond repayment will be R9,983.80 per month, with a total repayment of R2,396m. Should the interest rate increase by just 0.25% to 10.75%, the monthly repayments will be R10,152.29 and the total repayment will increase to R2,436m over the 20-year term.
That equates to an additional repayment of R40,437.76 – a significant amount of money from such a small shift. Homeowners must consider what can be done to increase protection against these changes.
It costs money to fix the interest rate
Geldenhuys explains that banks hedge their own risk of the interest rate going up by only allowing the homeowner to fix a rate higher than the one currently being paid.
If a bond is subject to an interest rate of 10.5%, a bank might only allow fixing the rate at 11% or even 11.5%. This means that the homeowner will already be subject to potential future increases.
The rate cannot be fixed forever
Most banks limit the fixing of the interest rate to a specific term. This means that a homeowner can only be protected against fluctuations in the short term (between one to five years), but would have to renegotiate the rate at the end of that term.
“This means that the risk exists of losing out on incremental growth and adjustment over time, having to pay significantly more each month at the end of the term,” says Geldenhuys. “But this can be guarded against by watching the interest rate fluctuations to be aware of what might happen.”
A fixed interest rate allows for financial planning
The one benefit that fixing an interest does guarantee is that it allows for planning finances around a fixed cost. With so many other costs spiralling out of control it is reassuring for homeowners to know that one of their biggest monthly expenses will not change.
To fix or not to fix?
While many analysts will offer their opinion on whether the interest rate is likely to increase, remain unchanged or decrease, nobody can really tell. The Monetary Policy Committee has to weigh up a variety of factors when addressing this issue, and many of these factors change between each announcement.
Because it is impossible to predict the interest rate’s future behaviour, the decision to fix a home loan’s interest rate should be made for personal reasons. Consider: is it better to pay a little extra to be able to plan around a specific rate for a one- to five-year term? Or is it better to continue to ride the fluctuations?
This tricky decision can be navigated by making sure the outcome is in line with personal finance goals. Was the home bought as an investment over the long term? Or will it be sold in the short term? Considering these questions will help a homeowner decide on whether the home loan interest rate should be fixed.