Protect yourself against interest rate?hikes

2014-04-06 14:00

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The Reserve Bank chose not to raise interest rates at the end of March, but economists believe there is a strong possibility of rate hikes later this year.

Tightening your belt and adjusting your budget before the rate hikes kick in is a bright financial idea.

Several economists – including Arthur Kamp, an economist at Sanlam Investments, and Razia Khan, the regional head of research for Africa at Standard Chartered Bank – believe the interest rate hike in January this year was only the start of a hiking cycle, which will leave interest rates at a high of 11% in 2016.

According to Khan, the SA Reserve Bank is likely to want to ensure inflation is back within the 3% to 6% target next year, which implies a rate hike as soon as possible.

“However, we still think this will be a measured tightening, and we forecast a May 2014 rate hike to 6% and a July 2015 hike to 6.5%, with a further 100 basis points to follow in 2016,” she says. This would take the prime lending rate to 11% in 2016.

Prime refers to the benchmark rate at which private banks lend you money.

But John Loos, a property sector and household strategist at First National Bank, believes interest rates will peak at 11% even sooner – during 2015.

Anton de Wet, a managing executive of client experience at Nedbank, puts this into perspective. The biggest challenge for people in debt is resisting the urge to spend or incur more debt, as getting out of debt requires great discipline.

“It is important not to add to your debt – particularly now, given we are at the start of a rising interest rate cycle – as the cost of servicing this debt is also set to increase over the next few years.”

He explains that if you have a R500?000 home loan payable over 20 years, your current monthly repayment would be R4?498 at 9%.

If interest rates rise by just 1%, this repayment would increase by R327 to R4?825.

At an interest rate of 12%, the monthly repayment would rise by more than R1?000 to R5?505.

Loos says the rate hikes will impact the purchase of cars and houses as consumers absorb the higher cost of borrowing. “The long-term positive impact is that this should help restrict the growth of household credit to lower levels than growth in household disposable income,” he says.

Loos points out there has already been a decline in the ratio of debt to disposable income from 83% in early 2009 to 74.3% late last year.

What you can do to protect yourself

1?Borrow less

You should always borrow less than you can afford to borrow. This ensures you are able to weather the impact of interest rate hikes. When you are calculating what you can afford to borrow and how much your repayments will be, you should assume interest rates will rise by about 5%.

If you can’t afford the repayment at that level, you need to borrow less.

2?Watch inflation

If you are in the market to buy a home, take into account the costs in addition to the bond repayment and the effect inflation will have on those costs – for example, electricity, water, rates and maintenance.

Loos says in many cases, overcommitment is not related to a misunderstanding about how much it costs to repay the debt, but a misunderstanding about how much it costs to maintain and operate a home.

3?Save a deposit

If you cannot afford to buy a home right now, rent for a few years and use the time to save up for a deposit.

4?Trim your expenses

Cut back on nonessential expenses wherever you can. One of the easiest things to cut from your budget is your satellite TV subscription, which can save you up to R700 a month or R8?400 a year.

5?Consider a carpool

Find out if a neighbour works in the same area that you do, or set up a carpool with colleagues at work. This will help you save on petrol costs. But make sure you inform your insurer if you are using your car in a carpool arrangement.

6?Fix your home loan rate

De Wet says to gain certainty, you might choose to fix your home loan rate for a term between one and five years. This could ensure peace of mind during an increasing rate cycle, but you will pay a premium. One disadvantage is you do not benefit from a rate decrease.

If rates decrease below the level you have fixed your loan, you may apply for an early termination, which is assessed on a case-by-case basis and if it is agreed on by the bank, you will still have to pay an early termination fee.

7?Decrease your debt

If you have short-term, interest-bearing debt, such as store cards and credit cards, pay it off as quickly as possible so that you have a financial buffer in your budget to protect you from further rate hikes.

8?Increase repayments

If you are in a position to do so, pay an additional amount into your home loan every month. This will reduce your home loan repayment term as well as the total interest you pay in the long run.

If you set your monthly repayment significantly higher than the required repayment, this also alleviates any stress about meeting your home loan repayment when interest rates rise.

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