If you’ve been hunting down the perfect house, the announcement of a staggering 0.75% increase in the interest rate yesterday (21 July) by the South African Reserve Bank may have you spooked. As home loans are linked to the prime lending rate, which can change, and often does, when the interest rate is adjusted, you may be justified in feeling a little hesitant about buying a house right now.
You shouldn’t be though, according to Andrea Tucker, Director of MortgageMe. “When you register your new home loan, you can choose to one of two interest rate types: variable or fixed. A variable interest rate changes with the prime lending rate, while a fixed interest rate stays the same for a specific and agreed period of time. Understanding the difference between these two rates will help you to choose the one that best suits you, giving you a modicum of control over your budget into the future.”
How to decide whether to go with a fixed or variable rate?
Variable interest rate
Your home loan agreement will default to a variable interest rate when you’re contracting with a bank to wrap up your home finance. This means that when the bank adjusts its prime lending rate in response to a change on the repo rate, your monthly repayments will go up or down, depending on the size of the rate change. “So basically, you’re going to save money on your monthly repayments if the prime lending rate goes down, and conversely you will pay more if the prime lending rate goes up,” explains Tucker.
Pro: You could save money on your monthly repayments if the prime lending rate goes down as your monthly instalment is automatically adjusted according to the rate change percentage.
Con: Conversely, you will pay more if the prime lending rate goes up.
Fixed interest rate
Only once your bond has been registered can you apply for a fixed interest rate, but there is a strict time limit attached before the offer lapses, so don’t leave it too long before making your decision. The rate offered is dependent on the going rate at that specific time. Banks will offer to set your interest rate for a period of 12, 24, 36, 48 or 60 months, and your monthly payment will be fixed for the period that you select. When the fixed interest rate period has expired, your home loan will automatically revert to a variable interest rate.
Pro: A fixed interest rate lets you plan around your home loan repayments because you know exactly how much you will be paying for the period you choose.
Cons: Generally, a fixed interest rate is higher than a variable rate as it poses more of a risk to the bank. If the prime lending rate goes down, your monthly payments will remain the same.
Tucker’s advice is to do some research while you are house hunting to see what property specialists and economists believe the market is going to do in the short to medium term. “If the industry opinion is that interest rates are likely to increase significantly for the first 12 months or more of your bond, it might be best to fix your rate if you believe that your fixed rate will be lower than the overall increases over time, of course.” While market conditions are always a useful guide, the most important factor when deciding on whether to fix the interest rate or not should be your own personal affordability.
Online affordability calculators are available to assist you in determining worst case scenarios, where you can see how your monthly repayment can spiral out of control if the interest rate goes up drastically. Once you have received an offer from a bank that you’d be happy to accept, ask the bank to give you an indicative fixed rate, and use online calculators to work out the possible scenarios and what the impact these two rates would have over the life of your bond.
“Once you have gathered as much information as you can, ask professionals for their advice and calculated the best and worst case, go with that!”