Should you fix your bond?

2011-05-28 14:05

The banks are currently advising customers to consider fixing their home loans so that when interest rates increase, their monthly payments will not be affected.

In some cases the banks will only offer customers a fixed interest rate. In other words, no matter what happens to the prime lending rate, your home loan repayments remain the same.

This is usually for customers who have had a problem with their credit history. The banks want to ensure that the customer can afford to repay his or her mortgage irrespective of the interest rate cycle.

For other customers, it is an option that is available. But bear in mind that if you opt to fix your interest rate, you will pay a higher interest rate initially, so it is worth taking a closer look at your own finances before you decide.

No one knows exactly when interest rates will start to increase, but what we do know is that interest rates are going to rise within the next nine months. The question is by how much, and how many rate increases will follow?

Investec Bank expects the first interest rate hike to be in November and prime to move from 9% to 9.5%. However, the consensus is that we will see the first rate hike next February. Barclays Wealth expects to see a total 200 basis point hike by the end of next year, which means prime will have moved to 11%.

Keep in mind that if your mortgage increases from 9% to 11%, that is actually a 22% increase in the amount of interest you will be paying. So if your mortgage is R500?000, your repayments will increase by R830 a month.

That is money straight out of your budget that goes into the black hole of interest repayments.

If inflation remains under control, that will hopefully be the end of the rate hikes. However, if we see the same inflation cycle of the early 2000s and a similar monetary response from government, we could see interest rate hikes of 500 basis points increasing that R500 000 mortgage repayment by R2 000 a month. That is serious money.

Does fixing your bond make sense?

It really comes down to a bet against the bank. Currently, FNB is offering a five-year fixed interest mortgage rate at 225 basis points above your current mortgage.

So, for example, if your mortgage is currently 8.5%, then you would start paying 10.75%.

That would increase your repayments by about R850 a month – all of that extra money will only go to pay interest, not your capital. You are in effect buying insurance against a rate hike going higher than 2.25%.

It makes more sense to take the 225 basis point increase the bank will charge you (R850 on a R500 000 mortgage) and pay that into your mortgage every month starting next month.

You will be paying off capital, not interest, so you will therefore be lowering the amount you owe the bank.

It will take at least 18 months to two years for actual interest rate hikes to reach that level, and if they surpass it, the extra that you have paid off on your mortgage will give you credibility with the bank if you need to renegotiate.

Whatever you decide, what is important is that if you have a home loan, you must start to budget for an increase so that you do not find yourself in financial difficulty.

Start paying whatever extra money you can afford into your mortgage and allocate a portion of any salary increase you get towards your mortgage. Losing your home is not an option.

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