Rising interest rates pose the question of fixing

HIGH — and rising — interest rates are making property unaffordable for many potential first-time home buyers. For those buying a home, the first big decision is whether or not to fix the interest rate on their bonds. There is a lot of uncertainty about which way interest rates will move over the next year.

Renting a property in the short to medium term could be the better bet, but this option is also not without risks.

First National Bank (FNB) property strategist John Loos says there is no cut and dried answer on fixing rates because everyone’s financial situation differs, and so does their appetite for risk.

What is needed by prospective home owners is “scenario planning” for a rise or drop in interest rates.

FNB is expecting a 50-basis-point hike in interest rates this week and believes there is a good chance rates could then move sideways.

“But having said that we realise there are numerous risks to such a forecast and fixing interest rates is done exactly to eliminate those risks,” says Loos.

“People mustn’t view fixing interest rates as a way to beat the market. It is about getting certainty over a portion of your cash flows and sleeping more easily at night.”

Loos says that if some “unforeseen shock” hits the market and interest rates rise substantially further, fixing interest rates can cover the home buyer.

“But the price you pay for eliminating that risk is that if interest rates go down you may lose out to a certain extent by fixing your rates. That’s the trade-off.”

Loos does not believe it is a “doom and gloom” scenario for home owners. “No matter where in the interest rate cycle you buy your home, you must at some point anticipate rising interest rates. While we don’t forecast cycles accurately, the prospect of rising interest rates at some point is almost as certain as death and taxes.

“What we always should be doing as a home owner or prospective owner is scenario planning and asking the question: ‘Would I be able to afford all this debt should interest rates rise by another three to four percentage points?’ One should especially do this planning when interest rates are relatively low in the cycle.”

Loos says another option is renting because in many areas of SA people would be able to obtain rental property where the monthly payment is lower than a 100% monthly bond repayment.

In addition, the rental option could offer more cash-flow certainty as provision could be made in rentals for a lot of the maintenance expenditure.

“The downside to renting is that in the end you don’t own a valuable asset, and annual rental escalations can mean that you end up paying more than your monthly bond repayments would be some years down the line.”

He says renting can be a good option as a “short-term cash flow management measure”, and there will be some strengthening in the rental market driven by higher interest rates, as well as the effects of the new National Credit Act “pushing a few more people out of the buying bus”.

Property economist Erwin Rode, of Rode & Associates, says the interest rate is the most difficult variable of all to forecast.

“Witness that about two years ago, economists were of the opinion that we were at the peak of the cycle. So having said that, one must have pretty strong convictions on the future direction of interest rates to bet against economists at the banks.

“When banks fix your interest rates they take a view based on the opinion of their economists, and for anyone to bet against that view is dangerous.”

Rode says he has been saying for some time that people should be renting rather than buying in the current environment. This is for the simple reason that price-wise, the market is at the top of the cycle.

“From an investment point of view and cash-flow point of view, it makes more sense to rent at the moment,” he says.

Samuel Seeff, chairman of real estate group Seeff Properties, says that when people cannot afford to buy property because interest rates have gone up and they wish to experience a certain type of lifestyle, they have no option but to consider renting.

Seeff believes the question of fixing interest rates now is like “closing the stable door after the horse has bolted”.

“You needed to have fixed interest rates on bonds when they were around 10,5%, not 14%, as there is a premium attached to fixing.”

None of the commentators thought rates would go beyond the premium being asked for now. “The downside, if one has fixed, is if interest rates drop, you would be locked in at the higher rate.”

Article by: Nick Wilson - www.businessday.co.za