Should you fix your interest rate?

While the current prime interest rate is still considered to be comparatively low, Reserve Bank Governor, Gill Marcus, has forewarned the South African public that we are currently in an increasing rate cycle, and consumers should expect to see further rate hikes in the future.

In order for the homeowner to see the benefits of fixing their rate, the prime interest rate would have to increase by at least three percent to four percent during the contract period.

Adrian Goslett, CEO of RE/MAX of Southern Africa, says considering this, it is no wonder that many homeowners are contemplating fixing the interest rate on their bonds.

Who would benefit from a fixed interest rate? Goslett says for homeowners who are risk averse or who want to have a fixed bond repayment that they can include into their budget with no surprises, a fixed rate is a viable option to take into consideration. He says it is a particularly good option for homeowners who can’t have any variations in their budget due to the fact that they are currently stretched to the limit financially and will not be able to handle any further repayment increases for a fixed period.

He says a home loan rate can generally only be fixed for a maximum period of five years, depending on the financial institution.

According to Goslett, while there are benefits for homeowners who would like to fix their bond rate, there are a few elements that should be considered before they make their decision. He notes that although a fixed rate will mean that the homeowner’s monthly bond repayment will not increase over the agreed period of time while the rate is fixed, it is important to note that a fixed rate is on average around 2.5 percent higher than the current prime rate.

“The fixed rate percentage given to a homeowner can vary depending on the terms of the contract and the bank at which the home loan is held, however, homeowners can expect to pay a higher rate than the prime rate. While fixing the interest rate will provide some cushion for homeowners if there are successive rate hikes over the term of the contract, if there are no or limited rate hikes, the homeowner will have paid more for their bond than those who have their bonds linked to the prime lending rate.”

Goslett says in order for the homeowner to see the benefits of fixing their rate, the prime interest rate would have to increase by at least three percent to four percent during the contract period.

He adds that when looking at the past history of the interest rate cycle, the general fluctuation is around the five percent mark over a five-year period. Even though interest rates are expected to increase as inflation continues to place pressure on the Reserve Bank, with the current economic climate there are doubts that they will see an increase as high as five percent over the next five years, however, the possibility cannot be ruled out entirely.

Goslett says, generally, fixed interest rate agreements range between one and five years, with exceptions given by certain financial institutions. Once the period has expired, the home loan will automatically revert to the prevailing home loan variable rate. He says if a homeowner wishes to do so, they can apply for a new fixed rate contract a couple of days before their contract has expired, however, the new contract will be negotiated on the current prime interest rate at the time. The fixed rate option will end either once the property is sold or the bond is fully paid up.

“While it depends from one bank to the next, there are instances where a homeowner can cancel their fixed rate contract by giving notice, however, the cancellation could be subject to early termination interest or a penalty that will be charged to the account. Homeowners will need to check what options are available to them and whether an administration fee will be charged to a fixed rate contract before signing.”

Goslett says it may be more beneficial for homeowners to pay the extra money they would pay when fixing their rate directly into their bond. This will reduce their loan period as well as the capital amount owed. He says reducing the loan period is just as important as the interest rate for homeowners to take into consideration. Aside from reducing the term of the loan, it will also decrease the total interest paid over that period, he says.

Many consumers have interest-bearing debt, so perhaps the best way to alleviate the stress of increasing interest rates is to pay off all high interest, short-term debt as soon as possible.