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Fixing Your Home Loan

Is it a Good Idea to Fix your Home Loan Rate?

To fix or not to fix? This classical question must cross the minds of many South African homeowners every time the repo rate notches up another gear. The latest decision made by the Monetary Policy Committee to maintain the repo rate at 11% brings reprieve – albeit temporary - and affords homeowners time that could be well spent on revisiting their biggest and longest term debt: the home loan.

As with all things financial, there simply is no such thing as a ‘one size fits all’ solution. In determining whether it would be a good idea for you to change your variable rate home loan to a fixed rate home loan, it is advisable to first understand exactly what a fixed rate home loan is and how it works, secondly what the impact of switching to a fixed rate will be, and finally how you can go about making the change.

What is a fixed rate home loan and how does it work?

Unlike a variable rate home loan, a fixed rate home loan is a mortgage where the interest rate applied does not fluctuate in line with changes made by the South African Reserve Bank to our repo rate. The interest rate is ‘fixed’ at a certain percentage by the lending institution when you sign your home loan agreement with them.

Unlike the U.S.A. where fixed rate home loans are literally fixed for the duration of the home loan (15yrs, 20yrs, 30yrs or even 50yrs in some instances), the fixed rate home loan products offered in South Africa are fixed for a considerably shorter period – currently a minimum of one year and a maximum of ten years, depending on which financial institution you are dealing with.

It is not only the interest rate that is fixed at the point of signature. The term you select is also fixed. The banks and other lenders make it abundantly clear that you cannot terminate before the contract expires.

When the term ends, you have one of two choices. You can either revert to a variable interest rate or you can re-enter into a fixed term agreement. If you choose to continue with the fixed term option, the prevailing fixed term interest rate will be applied.

What is the impact of switching to a fixed rate?

The most obvious impact of a fixed rate home loan is that it protects home owners from upwardly mobile repo rates. On the flipside, it also denies home owners the benefits of a reducing repo rate.

A further impact is that the home owner is contractually bound to the term of the agreement. A penalty, roughly equal to three months’ interest, could be incurred. In most instances, should you decide to move your home loan to a different financial institution, the banks and non-bank lenders are prepared to accept a three month notice of your intent. To be on the safe side, be sure to read fine print.

The least obvious impact is timing. When variable interest rates are low, fixed rate interest rates are also low. When the variable interest rates are high, the variable interest rates are also high.

If you opt for a fixed interest rate when prime is around the 10.5% mark (as it was before June 2006), you will probably be able to secure a fixed rate home loan at anything between prime plus 0.1% and prime minus 1.7%, depending on the term of the loan and the value of the loan. In other words, the worst case scenario would be that you pay an interest rate of 10.5%.

If, on the other hand, you convert to a fixed rate when prime is 14.5% (like now), your fixed rate – depending on the term and size of the loan – will range from a best case scenario of 12.85% to a worst of 14.55%.

In a perfect world, South African homeowners would have made the switch 19 months ago when the chips were up. But the world is far from perfect. In a real world, it is during those times when the chips are down that homeowners rush to the lenders to fix their rates. The impact? You will probably end up paying more when the tide begins to turn.

How do you convert to a fixed rate?

If you choose to convert to a fixed rate, there are two ways to approach the matter: The first is to consult the lending institution where your mortgage is currently held. The second is to consult a mortgage originator.

Considering that you will be locking yourself into a fixed rate, fixed term agreement, it would be wise to have a mortgage originator help you source quotes from the major banks, private banks and non-bank lenders. They can advise you on the length of the agreement most appropriate to your situation and negotiate the best possible rate on your behalf.

So, what is the bottom line?

Fixing your home loan rate is good if:

You fix the rate while the interest rates are very low;

You will be unable to meet your repayments should interest rates continue to rise;

You are completely risk adverse, and prefer knowing how much you will pay each and every month, upfront.

Considering that more hikes are likely during the course of this year, fixing your home loan for 12 or 18 months might be a good idea. But then, what is good for one person is not necessarily good for another. Perhaps consulting a mortgage originator or a bank consultant will help you to select the most appropriate option for your particular set of circumstances.

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