Interest rates are expected to remain high this year but fixing your home loan rate to compensate for any nasty surprises may not be your best idea.
It may even be a downright bad decision.
This is because a fixed interest rate should be a choice based on your appetite for risk, not the fluctuation of the prime lending rate.
If you believed otherwise, however, you can be forgiven. In fact, when the interest rate started its climb after record lows in 2020, many people started squirming, wondering if they should be fixing their home loan rates to protect against future hikes.
Unfortunately though, it is not a one-size-fits-all situation as the decision depends on each individual’s appetite for risk, says FNB property economist John Loos. As such, he never issues blanket advice on whether it is best to fix rates or keep them flexible.
Basically, fixed rates should not be used as a tool to try and beat the market.
“You fix your rates to sleep comfortably at night; you fix your rates to have certainty over a portion of your cash flow. And you live with your decision, knowing that you may ‘lose’ some and you may ‘win’ some, depending on where interest rates move to in future.
“The main reason for fixing rates is because the future is uncertain.”
Be warned: Fixed rates could be higher
If you are still inclined to fix your home loan interest rate based on a climbing prime lending rate, you will probably discover that the fixed rate you are offered will be higher during interest rate hiking cycles. This, he explains, is because banks also need to avoid the risks associated with clients’ variable rates.
When fixing you home loan interest rate, banks will look at the future expectations of the prime lending rate and base their fixed rate offer on that. Thus, if the market expects interest rates to increase, the fixed rate you are offered will often move higher.
“If you are keen on fixing your rates, the time to look for more attractive fixed rates is often when interest rates are being cut or expected to be cut. Ironically though, this is normally the time when few people are looking to fix their rates,” Loos states.
Echoing this, Bradd Bendall, head of sales at BetterBond says there is, unfortunately, no simple answer when it comes to evaluating the benefits of a fixed rate against those of a variable interest rate.
“Each buyer’s financial situation is unique.”
He explains, however, that, when applying for a home loan, it is by default on the basis of a variable interest rate.
“Only once your bond has registered can you apply for a fixed interest rate, and there is a strict time limit attached before the offer lapses.”
He says the following factors will help you decide on the most suitable interest rate options for your specific needs:
– Understand the repo rate and prime lending rate
The repo rate is set by the Reserve Bank and indicates the rate at which they loan money to commercial banks. It is not the same as the prime lending rate, which is the rate at which banks lend to consumers.
“Banks have running costs and other expenses which, when calculated with the risk of loaning money, result in the prime lending rate...The interest rate which banks will offer depends on your credit profile – including whether you have maintained regular payments, and affordability.”
Currently, the prime lending rate is 11.75 percent.
– Loan term
Bendall says fixed interest rates are set for up to five years, which means that on a 20-year loan you will need to renegotiate the terms. These terms could be less favourable than they were before.
“Generally, a fixed interest rate is higher than a variable rate as it poses more of a risk to the bank. It is only negotiated at the time of bond registration and the rate offered is dependent on the going rate at that specific time.”
– Loan repayment period
The longer the loan repayment or amortisation period, the more influence a change in the interest rate will have on your repayments.