Interest on credit is nobody’s friend, which is why it is always a good idea to negotiate the most favourable rate, particularly on a big ticket item such as a home loan.
Making an informed decision about the interest rate you’re committing to, whether fixed or variable, is a crucial part of purchasing a property, says Carl Coetzee, chief executive of bond originator BetterBond.
With a variable interest rate the interest charged on the outstanding balance of the loan varies in accordance with changes to the market interest rate. A fixed interest rate, on the other hand, sees the rate of interest charged on the loan amount remaining unchanged for the duration of the loan/fixed period.
“The question around which is preferable, a variable or fixed interest rate, is largely contingent on the market conditions at the time of securing the loan, as well as the loan period,” he explains.
* Viva variable: Studies have found that, over time, borrowers on a variable interest rate are likely to pay less overall than on a fixed interest rate.
“While this is useful to consider, one must also acknowledge that past trends don’t necessarily offer a clear indication of future performance,” Coetzee says.
A variable interest rate is linked to the prime lending rate as determined by the Reserve Bank, which means changes in the prime lending rate will cause your interest rate to go either up or down.
Variable interest rate bonds are typically granted at “prime plus” or “prime minus”, depending on factors such as the applicant’s credit rating and risk profile.
“The general consensus is that a variable interest rate poses less of a risk for lenders, such as banks, which allows them to offer bond applicants more competitive rates,” Coetzee says.
* Forever fixed: In South Africa a fixed interest rate on a home loan is determined by the bank or financial institution, independent of the prime interest rate. While this offers a sense of stability for lenders who can’t afford even slight fluctuations in their monthly repayment amounts, fixed rates tend to be around 2% higher than variable rates.
“In this example prime would have to increase by 2% or more for the fixed interest rate lender to reap any financial benefits from a fixed interest rate,” Coetzee notes.
Important to take into account too is that fixed interest rates are usually only for short periods – up to five years – and when you consider that the typical home loan period is 20 or 30 years, you’ll need to renegotiate the terms for a new fixed-fee rate, which might then be less favourable than what you had before.
* Making the decision: Other factors that must be taken into account is the amortisation period of the loan, which refers to the total length of time it takes to pay off a loan.
By extension, the longer the amortisation period, the bigger influence a change in the interest rate will have on the payments.
“At the end of the day, the decision is less about preference and more about your personal financial situation.
“A bond is a big deal, which is why it is crucial to work with experts who are adept at ensuring the best deal for you.”