Interest rate: Pros & Cons

2014-04-20 15:00

Is this the time to fix the interest rate on your home loan? What is involved, what is the alternative and what are the costs?

Typically, when you take out a home loan, you have what is known as a “floating or variable” interest rate, which is usually linked to the prime lending rate.

The prime lending rate is at 9%. The recent prime rate of 8.5% has been the lowest that interest rates have reached in the past 20 years.

The highest was 25.5% in 1996.

While fixing your home loan rate will grant you certainty for a period, fixed rates are generally a few percentage points above the interest rate you will pay on a variable rate bond.

Steven Barker, head of secured lending at Standard Bank, says this premium could be between 50 and 200 basis points, which will take your fixed rate to a maximum of 2% more than you will pay on a variable interest rate.

Peter Swartz, head of business development at Absa’s home loans division, says the exact fixed rate offered will differ from customer to customer, and depends largely on your individual credit risk profile as assessed by the bank.

Other factors that may affect the fixed rate offered to you include the size of your home loan relative to the value of the property and the length of the term for which the loan is fixed.

Nedbank was the only bank willing to tell City Press what its fixed-rate premiums were. If you have a home loan with Nedbank, these are the fixed-rate premiums you can expect to pay. Note that this will be an increase over the variable rate that you will pay.

For example, if you have a home loan at prime plus 1% (10%) and you opt for a two-year fixed rate, the rate on your home loan will rise to 12.55%.

One year?–?2.20%

Two years?–?2.55%

Three years?–?2.95%

Four years?–?3.35%

Five years?–?3.60%

Marius Marais, chief executive of First National Bank’s housing finance division, says 96% of FNB’s market comprises first-time homeowners.

“Due to affordability issues, these customers generally gear their loan to the maximum to purchase an entry-level house, which makes them the most vulnerable to changes in the interest rate.”

About 40% of FNB’s new home loans are on a fixed-rate contract.

“It seems we have now entered an upward rate cycle. However, what we can’t tell is how high rates will go and how quickly,” says Marais. He notes that although you will pay a higher fixed rate, this could be offset over time as interest rates increase.

Marais points out that in the past four cycle rates since 1994, the rates increased on average by 4% to 5%.

“No one knows exactly what is going to happen and the potential downside is that rates don’t move up past 2 percentage points, so it is up to the customer to decide whether to fix their rate.”

Different banks offer different periods to fix your home loan rate:

.?FNB housing finance offers a five-year fixed rate;

.?Standard Bank offers you a fixed rate over either two years or three years;

.?Nedbank offers fixed rates over 12, 24, 36, 48 or 60 months; and

.?Absa offers fixed rates over one, two or five years.

Says Marais: “If you measure the starting and ending point of cycles, they generally go in four- to five-year periods, hence our decision to offer a five-year fixed-rate period. Usually, five years mean an increase in household salary and the customer is in a better cash flow position.”

The alternative to fixing your rate

Steven Barker, head of secured lending at Standard Bank, says that if you are worried about your future cash flow, there are steps you can take other than fixing your rate. “An alternative is to prepay funds into your home loan with a view to reducing capital and protecting yourself from any interest rate shocks.

“Prepayment is an additional amount over and above your expected instalment and the amount can be as small as an additional R50 a month, or up to the total outstanding amount, depending on the funds you have available,” he says.

The cost of fixing your rate

There are no extra banking fees on a fixed-rate option. If rates decrease below the level fixed, you may apply for an early termination of your rate agreement.

This is assessed on a case-by-case basis and if it is agreed to by the bank, you will most likely have to pay an early termination fee.

Close to the end of the period, some banks will contact you with an option to either refix or revert to a variable interest rate.

The onus is on you to check what your bank’s default option is. In some cases, your loan will automatically revert to a variable interest rate.

RATE INDICATOR

How fixed rates affect what you will repay

On a R500?000 home loan, at prime plus 1% (10%), your monthly instalment will be R4?825. At a fixed rate, assuming 2% above this, your instalment will go up to R5?505, which is R680 more.

However, as the interest rate goes up, this gap will close by R335 for every percentage rate increase.

On a home loan of R1?million at prime plus 1% (10%), your monthly instalment will be R9?650. However, assuming that you fix your rate at 2% above this, your instalment will increase to R11?010?–?so you pay a premium of R1?360 for the certainty of knowing that your home loan repayment will not increase for a fixed period.

The disadvantage of a fixed rate is that you will not benefit from any interest rate decreases. So, if interest rates drop below your fixed rate in a year’s time, you could still be locked into a higher lending rate.

Contact details

Contact your bank to find out what fixed rate they will offer you and how it will affect your home loan repayment.

.?Standard Bank: SMS “fixed rate” to 32663 and a consultant will call you back, or you can contact the call centre on 0860?123?001.

.?FNB: 087?730?11?55

.?Nedbank: 0860?555?111

.?Absa: 0860?111?007

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