To fix your rate or not? Should I pay more on my home loan?
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With interest rates still at their lowest levels in almost 50 years, more and more homeowners are weighing the pros and cons of asking their bank to convert their home loan from a variable interest rate to a fixed rate for the next few years.
“Their common goal is obviously to be able to keep their monthly bond repayment at the current “pandemic” levels even when inflation starts to rise again and the Reserve Bank responds by moving rates back up too,” says Berry Everitt, CEO of the Chas Everitt International property group.
“And this is totally understandable, considering the continuous increases in food, utilities, medical costs, education, insurance and transport costs that are not under their control, and which make it harder and harder to budget.”
However, he says, there are several problems with this plan, the first being that most banks will charge borrowers a premium of at least 1,5% currently to fix the interest rate on their bond - and will also usually only fix a rate for a minimum of two years.
“The reason for this is that when the borrower fixes the interest rate, they are effectively asking the bank to take over their risk of future interest rate fluctuations, and that the bank expects to be compensated for that additional risk.
“And what it means is that anyone who is currently being charged an interest rate of 7,25% on their home loan, for example, would have to pay at least 8,75% for the next two years if they switched to a fixed rate option.”
Everitt notes that the effect of this premium would be to increase the minimum monthly repayment on a R1m home loan by R934 – which would be money totally wasted until or unless the variable rate applicable to that home loan also rose to 8,75%.
“Realistically, an increase of that magnitude over the next two years in SA is highly unlikely, and the waste would occur because the additional amount you would be paying every month would not help you at all to shorten the term of your home loan and thus save on the total cost of your home over time.”
However, he notes, if you could afford the additional R934, and you were to use it instead to reduce the capital portion of your R1m bond while staying on a variable interest rate, amortisation tables show that you would stand to lower the total balance outstanding from R1m to R965 000 within a year, and to R928 000 within two years (compared to R952 000 without the extra payment).
“This means that if and when interest rates do start to rise again, your minimum monthly bond repayment will be calculated on a much lower capital balance, and that even at 8,75%, your minimum monthly bond repayment will still be considerably less than you have been used to paying.”
In addition, says Everitt, you will have shortened the term of your R1m bond by at least a year - and cut some R69 000 worth of interest off the total cost of your home.
“Thirdly, staying on a variable rate now means that you will also benefit from any further cuts the Reserve Bank might make in future to try to stimulate the economy – and gain a further opportunity to shorten the term of your bond.
“And finally, if you have an access-type bond, you will always be able to withdraw any additional amounts you have paid into your bond account should you need them in an emergency. This is not something you will be able to do if you fix your rate now.”