With interest rates seemingly on an upward cycle, the issue of fixing home loans in the market becomes a hot topic. However, fixing interest rates on your home loan requires a carefully laid out strategy and not a knee-jerk reaction to interest rate increases.
Banks do not fix home loan interest rates based on the current repo rate, but on the market interest rate curves which are constantly changing.
“The market interest rates are as dynamic as the share market, meaning that market interest rates rise and fall continuously as new information becomes available to market participants,” says Tommy Nel, Head of Credit at FNB Home Loans.
The rate at which a bank will fix also depends on the period of time the customer chooses, up to a maximum of five years. There is a premium for raising funds for the longer periods of time, for example a fixed rate over 60 months will be higher than a fixed rate offered for 12 months.
The period of time as well as the expectation in the market for potential rate increases means that, on average, fixed rates will generally be somewhat more expensive than variable rate loans.
“Consumers should look at a fixed rate offering more like they would look at insurance products, such as buying protection or insurance against future hikes in the market,” says Nel. “I would also advocate against trying to time the market but rather work out your household exposure to rising interest rates.”
The best way to decide whether you should fix your home loan rate is to stress test your budget.
“Stress testing your budget is fairly simple and will give you a good idea where the breaking point is when it comes to interest rate hikes,” says Tommy.
In order to do this you will need to plan your budget as normal, using bank statements rather than memory. Work in contingent expenses such as funds for a car, holiday expenses or any type of non-regular expenses.
“Once you have a solid budget, you will need to ascertain each expense that is affected by a repo rate increase,” says Nel. “These include home loan debt, car debt, overdraft interest and credit card debt.
Test how much your repayments would increase for every 1% increase in the prime rate of interest. All banks should have a loan repayment calculator which can help you. For credit card and overdraft debt you can take your average monthly balance or estimate and multiply this by 1%, 2% and so on.
“This will help you to develop a strategy on whether to consider fixed rates as you will soon see at what level of interest rate increase shortfalls begins to materialise in your budget,” says Nel.
For example, if with a 1% or more increase in interest rates you will start to experience financial stress, fixing your interest rate at anything up to 1% above your current variable rate would have effectively helped you in significantly reducing the risk of losing your property.
“A key part of implementing this strategy is thinking about it in terms of risk management and a decision to protect yourself from losing your property,” says Nel. “There is always a possibility that some customers might end up paying a little more than what they would have on a variable rate loan, but it may well be worth it from a risk management and peace of mind perspective.”
In South Africa, at present, fixed rates are only available up to a maximum term of five years.
“One of the main reasons for this is probably the elevated levels of risks faced by banks in implementing risk management strategies to hedge it fixed rate risk exposures, and the fact that these costs cannot be passed onto consumers like in other countries where fixed rates of much longer periods are available,” concludes Nel.
Alan Straton
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