September 26, 2009
By Neesa Moodley-isaacs of www.persfin.co.za
The South African Reserve Bank has lowered interest rates over the past 15 months, from 15.5 percent in June last year to their current level of 10.5 percent, to the advantage of homeowners with a mortgage bond. You may be asking yourself whether now is the right time to fix the interest rate on your home loan.
Property economist Erwin Rode says fixing the interest rate on your home loan is dangerous, because you are effectively betting against the banks' view of how interest rates will move in future.
"The global economy is so uncertain that, who knows, maybe interest rates will drop further over the next year in a desperate attempt to salvage the economy.
"A further point to contemplate is that fixing the rate on your home loan does come at a price. The fixed rate is usually higher than the variable rate you would get if your interest rate was linked to prime," Rode says.
The prime lending rate - the rate on which the banks base the interest rates they charge you - is 10.5 percent. If your interest rate is not fixed, the variable rate that a bank charges you is linked to prime and is based on the size of your loan and credit profile. The rate could be prime (10.5 percent), as much as prime plus two percentage points (12.5 percent) or as low as prime minus two (8.5 percent) if you took out a home loan several years ago.
Most banks stopped giving clients variable interest rates as low as prime minus two during the course of last year.
You can arrange a fixed interest rate on your home loan for between one and 10 years. However, the longer the period you choose, the more you are likely to pay for the certainty of a fixed rate.
Certainty at a price
John Loos, a property strategist at First National Bank (FNB), says your decision whether or not to fix your interest rate will depend on how conservative you are. Or you may feel that your financial situation is quite precarious and that it will not withstand interest rate hikes, which would push up your home loan repayments.
"Basically, when you fix the interest rate on your home loan, you are palming off future uncertainty about interest rates on to the bank - which you will pay a fee for," Loos says. He cautions that you should not see fixing your interest rate as a way to beat the market but rather to gain certainty over your cash flow.
The fixed interest rates on your home loan are linked to market expectations of where rates may be going. You will receive a better fixed rate when interest rates are falling and the market is pricing in further rate cuts.
Loos says a common mistake that people make is to wait for the first interest rate hike before they decide to fix their rate so that they "don't lose out on any rate cuts".
"However, the market will by that stage have priced in further interest rate hikes, and you are unlikely to get an attractive fixed rate. Although you may lose out a little if rates drop further, that is the price you pay for the certainty of a fixed interest rate," he says.
For example, according to figures supplied by FNB (see the "Take-up of fixed rates vs the prime lending rate" graph), there was a take up of fixed interest rates on home loans from February last year, which was well into the series of interest rate hikes that started in June 2006.
A large spike in the take-up of the fixed-rate option took place in June last year. This uptake was aligned with the last interest rate hike and occurred when interest rates had reached their highest level in two years.
Luthando Vutula, the managing executive of Absa home loans, says a fixed-rate option could negate the impact of interest rates on your cash flow in an environment where interest rates are likely to increase in the future.
Pramod Mohanlal, Nedbank's divisional general manager for home loans, says you should bear in mind that fixed-rate contracts carry financial penalties if you cancel the contract prematurely.
"Depending on the term of the contract and the value of the mortgage bond amount, this [penalty] may constitute a substantial amount. If you are enjoying a favourable discount to the prime rate, you should consider your options carefully and consult various banks before committing to a long-term fixed-rate contract," Mohanlal says.
Jan Kleynhans, the chief executive of FNB home loans, says opinions differ about where we are in the interest rate cycle.
"Some believe we are nearing the bottom of the cycle, while others believe the economy still requires a boost through further rate cuts. In line with that thinking, we have not seen a significant increase in the take-up of the fixed-rate option on home loans, and the majority of take-up is usually seen after the initial interest rate hike," he says.
Factor in rate hikes
Prem Govender, an independent financial planner with Mosswick Investments and the director of the South African Savings Institute, says you should take the interest rate cycle into account when you are applying for finance to buy a home. "By that I mean it is important to factor into your budget any possible interest rate hikes in the medium term. For example, the prime lending rate is 10.5 percent, but the prime lending rate can rise steadily if and when interest rates are increased. So, if you are buying now, you should factor into your budget increases of at least another five percentage points so that you know you will be able to afford the bond repayments even if the prime rate increases to 15.5 percent."
Govender says this will help to cushion you against interest rate increases, and you will not have to fix your interest rate.
Another option she suggests is that you calculate the additional money you would have to pay each month if you fixed your interest rate and simply increase your bond repayment by the same amount. "In this way, you can build up a buffer in your home loan and, if interest rates do rise, you will already have worked this into your budget," Govender says.
THE RANGE OF FIXED RATES YOU CAN GET
When a bank offers you a fixed rate on your home loan, one of the things it takes into account is the loan-to-value ratio on your loan. This is calculated by dividing the outstanding balance on your loan by the value of your home.
The fixed rate you are offered may vary, depending on your credit profile, and the fixed rates on offer can change from week to week. However, the following figures, as at September 17, may be used as rough guidelines of what you can expect:
Absa offers fixed rates of between 10.45 percent and 11.55 percent for one year, and between 10.8 percent and 11.9 percent for two years. There is no once-off fee to fix your rate.
First National Bank offers fixed rates of between 11.5 percent and 14.4 percent, depending on the outstanding bond amount and the term of the fixed-rate contract. You can fix your rate for 12, 18 or 24 months. You will have to pay a once-off variation fee of R250.
Nedbank offers you fixed interest rates for 12, 24 or 60 months. The bank declined to commit to a range of fixed rates, saying that fixed rates are calculated after taking into account your credit profile, interest rate volatility and the cost of funding. Nedbank does not charge a once-off fee to fix the rate.
Standard Bank offers you fixed interest rates for 12, 18, 24 or 36 months. Standard Bank does not charge a once-off fee to fix the interest rate. If you take out a fixed-rate contract and then cancel the contract early, you will be charged a cancellation fee of 1.5 percent of the value of the outstanding loan, calculated over the contracted term of the fixed rate. The cancellation fee is based on the outstanding balance at the time of the cancellation on a pro-rata basis for the unserved fixed-rate period.
WHERE MIGHT INTEREST RATES BE HEADED?
We are at or near the bottom of the interest rate cycle, Loos says.
"There may be another cut of half to one percentage point, but this will not make a huge difference to the banks. I believe we will start seeing hikes in the interest rate from the second half of next year," he says.
But Rode says there are as many economists who believe we have reached the bottom of the interest rate cycle as there are those who reckon the Reserve Bank should drop rates by another half to one percentage point.
"Either way, there is a case to be made and it would be folly for an individual homeowner to try to put money on how interest rates will move," he says.
Rode says if you are going to bet against your bank, you should rather "go for broke" and fix the interest rate on your home loan for a long time.
Economist Carmen Altenkirch of Nedbank says although the Reserve Bank kept interest rates at their current level this week, it is not clear whether this is the end of the current cycle of interest rate cuts. "Our forecast is still for one last cut in the repo rate, to 6.5 percent, from the current seven percent, taking the prime interest rate to 10 percent by the end of the year," she says.
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