To fix or float your home loan?

Earlier this month, the South African Reserve Bank announced that the interest rate would go up by 25 points. The announcement came amid a 50 point increase imposed by the Reserve Bank earlier this year. Economists predict a further interest rate increase that could see the prime rate rise to 9.75% and some even suggest that we could see a prime rate of 10% within the next 18 months.

In light of this, many consumers are wondering whether now would be a good time to fix or float their home loans. But according to Mike van Alphen, National Manager of Rawson Finance, it appears that we are in an increasing rate market, which is not a good time for fixing rates.

Not a good time to fix home loan rates

South Africa’s economy has experienced an extended period of abnormally low interest rates since 2008. Nine years ago, the prime rate reached 15.5% while in 1984 it reached 25%.

The new rate will affect consumers’ ability to borrow money and many consumers could be considering ways in which they can beat the market by either fixing their rates.

Van Alphen explains that a fixed rate is always 2% or more above the floating rate, depending on the period that the client decides they want to fix their rate for.

“The periods offered vary from bank to bank but normally a rate can be fixed from 12 to 60 months. The longer the fixed period, the higher the rate is above the floating rate. A client can beat the market if his fixed rate falls below the floating rate in a rising interest rate market. But this will happen only if the fixed rate remains lower for a longer period time than what it was above the floating rate,” says Van Alphen.

But this is unlikely to happen. Van Alphen used the scenario where should a bondholder fix his rate today at 11.50% for five years and the rate climbs above that (an increase of 3% on today’s open bond rate), his fixed rate would be just below the open rate. But for him to have beaten the market the rate would have had to climb to this level in the next two years and then continue to climb over the following three years.

Van Alphen adds that the benefit of a fixed rate is that it allows the client to budget more easily and plan future expenditure more accurately because the fixed rate will not be influenced by the floating rate’s increases.

“At the end of the fixed period, the client has the option of converting to a fluctuating rate or fixing the rate for a further period of time taking into account the market trend at that time and the client’s personal financial circumstances,” says Van Alphen.

Consumers, who are now aware of the pitfalls of having a fixed rate as an option, could be considering the benefits of opting for floating rates when it comes to their home loans. Van Alphen says that due to that fact that the fixed rate being offered at the time may well be 2% to 4% higher than the then prime rate, the gap may widen should the prime rate go down during the period of the fixed mortgage. Within a fluctuating/floating rate, the client would benefit from a decrease in the prime rate.

Van Alphen adds that a floating rate would be beneficial for any client who has a reasonable rate concession on their mortgage bond as they would lose this benefit should they fix the rate. Homeowners with a healthy income, subject to annual increases, may also benefit from a floating interest rate as they will be able to budget accordingly.

With all things to consider, which type of individual would then benefit by fixing the rates of their home loan?

Van Alphen says a fixed rate mortgage may well benefit clients who have minimum potential for future income growth as the fixed repayment will give them peace of mind and protect them from increasing repayment amounts as rates increase.

Jacques du Toit, Property Analyst at Absa, says the outlook for domestic interest rates for the rest of the year depends on global and domestic economic developments and movements in key economic indicators such as GDP growth, inflation and the factors affecting inflation. This will impact household and company finances as well as consumer and business confidence and spending.

“With household debt levels remaining relatively high, rising interest rates will cause debt repayments and debt servicing costs to increase and adversely affect consumers’ financial position and the demand for affordable credit,” says Du Toit.

Both Absa and FNB advise that a client should not consider fixing their interest rate during a period of rising rates as fixed rates would normally became unattractive as they would take into account future potential increases.

Absa announced that its prime lending and variable mortgage interest rates will rise from 9% to 9.25%, effective Friday, 18 July 2014.

The decision to fix or not is very much dependent on the homeowners personal financial position and must be very carefully considered by seeking the assistance of financial specialists.

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