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, as we are now, 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 10.5%). The bank does this to shield itself : broadly speaking it doesn’t want to be caught in a situation where your monthly repayments are lower than their repayments to the SARB.
It is worth noting that you can only apply for a fixed rate after registration of your home loan and the bank will then determine what rate they are willing to offer you based on economic factors and bank strategy. Whatever the outcome of such an assessment the fixed rate is invariably considerably higher than the prvailing prime rate.
As an example:
A bank offers a, generous, fixed rate of 1% above prime for 12 months and at the end of April 2016 Clients X and Y both have R 1 000 000 loans at prime (which at the time was 10.5%) and repayment terms of 30 years.
In 2015 economists had predicted an increase of anywhere up to 2% in the repo rate across 2016. X ignores these predictions leaving her rate variable and Y takes them to heart and fixes his rate for 1 year at 11.5%. Within days the SARB increases the rates and prime goes up to 11%. Y might feel vindicated. The SARB then keeps the rate level until increasing it September 2016 and again in January 2017.
X now has a rate of 11% and in May pays R9523.23. Y has his fixed rate of 11.5% and pays R9902.91.
Now let’s say the SARB increases the rate by 0.5% to 11.5% in September and again in January at which point it keeps the rate stable at 12% until April 2017 when Mr Y’s fixed term ends.
Mr Y will have paid for all 12 months totalling R118 834.9.
Ms X will have paid R9523.23 for 4 months, R9902.91 for 5 months and R10286.13 for 3 months totalling 118 465.86.
Ms X has paid R369.04 less than Mr Y despite 3 increases to the rate. This scenario is quite likely given the current path inflation is taking and you would be VERY lucky to receive a fixed rate of only 1% above prime in the current climate.
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 2008/9) 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.
Read our post for far more effective tips of saving money on your home loan.