The interest rate on your loan, unless you have specifically negotiated with the bank, is directly linked to the South African Reserve Bank (SARB) repo rate. Briefly, the repo rate is the rate at which the SARB lends money to commercial banks. The SARB announces rate changes approximately once every two months. The commercial banks pass on any cost of increased lending from the SARB onto their clients. So this means that when the SARB pushes up its rate your monthly home loan repayment will increase (and vice versa).
When faced with the likelihood of these increases home owners become understandably nervous and look for ways to insulate themselves from higher repayment costs. This is the time when many people become interested in ‘fixing’ their interest rates.
Unlike the standard, variable rate linked to the fluctuations of the repo rate the fixed rate is one you can negotiate with the bank and is set at a level for a period of, generally, between 1 and 5 years. This negotiated level is independent of any increases or decreases in the repo rate and will remain constant (fixed) for the term you agreed to. Now this may sound like the perfect shield against rocketing costs but it really isn’t. Why?
It won’t save you anything! This is because the rate you negotiate with the bank will always be higher than the current prime lending rate (as of writing prime stands at 9%). The bank does this to shield itself from increases to the repo rate: broadly speaking it doesn’t want to be caught in a situation where your monthly repayments are lower than their repayments to the SARB.
As an example:
ABSA offers a fixed rate of 0.9% above prime for 12 months. In 2013 economists had predicted an increase of anywhere up to 2% in the repo rate across 2014.
At the end of January 2014 Clients X and Y both have R 1 000 000 loans at prime (which at the time was 8.5%). X ignores the predictions leaving her rate variable and Y takes them to heart and fixes his rate for 1 year at 9.4%. Within days the SARB increases the rates and prime goes up to 9% and Y feels vindicated. The SARB then keeps the rate level and increases it September and November.
X now has a rate of 9% and in February pays R8046. Y has his fixed rate of 9.4% and pays R8 335.
Now let’s say the SARB increases the rate by 0.5% in September and again in November at which point it keeps the rate stable at 10% until January when Mr Y’s fixed term ends.
Mr Y will have paid R8335 for all 12 months totalling R100 020.
Ms X will have paid R8046 for 7 months, R8 408 for 2 months and R8 775 for 3 months totalling R99 4630.
So we see that despite 3 increases to the rate, which would represent a significant change to SARB’s stated goals, Mr Y has made no saving at all.
When you fix your rate it is almost like a taking a bet: you’re betting that the rate is going to increase so drastically that the fixed rate actually saves you money and the bank is betting against you. But before you try your luck remember that to ensure its profitability the banks pay teams of trained professionals exorbitant salaries to assess risk and assign value to investments. And so, barring a significant financial crisis (worse than the one experienced in 2008) fixing is almost certainly not going to work in your favour. The house always wins and in this case the house is playing entirely with your money.
