To fix or not to fix? That is the question.

Until recently, South Africans had a very limited option in terms of fixing a rate on their bonds. Financial institutions allowed bondholders to fix their rate for up to 2 years maximum. This was usually at a premium to the prime rate. Nowadays, some new innovations have allowed SA Home Loans to offer a 20-year fixed bond rate at prime plus 1.5% or 12% at the current prime rate. The question is: do I fix my bond rate at this rate for 20 years or not? The facility does exist to refinance at a lower rate if the prime rate does drop too, so this fixing will really protect you on the downside, that is, if rates start to go up but still give you the option of moving down should rates drop.

This all makes sense in a rate uncertain environment, but we need to look at the cost of this fixing in relation to the risk. If you can get a rate of prime less 2% on your bond, this fixing comes at a cost of 3.5% to you. The difference between what you get and what you'll be moving to. On a R500 000 bond this makes a difference of around R1200 per month. In effect you're paying an insurance of R1200 per month that the interest rate isn't going to go up more than 3.5%.

A better way of dealing with this option is to only fix a portion of your bond. For example, if you fix half your bond, you will be limiting half the risk and only paying half the rate. SA Home loans also offer normal fluctuating bonds at around prime less 2%. It is possible to opt to fix half your bond and keep half on the fluctuating rate. This will mean that you are paying a rate equivalent to the average between the two or 10.25% (prime less 0.25%). The effect of this is that if rates go up, you are only exposed to half the rate increase. On the above example, your 'insurance penalty' would be around R570 extra per month or about a 13% extra. If rates jump 10% in the next two years (unlikely, improbable, but not altogether impossible), your R570 would be well spent and your bond repayment would move by half as much as other unfixed bonds.

Having said all this and having worked out the entire math, you need to make an assessment of the likelihood of this risk ever materialising. In practice you are only reaping benefit when the interest rate moves above your fixed rate, i.e. 12% or an upward move of more than 3.5%. The last two decades have brought similar drastic fluctuations but they need to be seen in a context of an economy moving from a closed to an open system. An event that cannot happen again and another event of similar magnitude is unlikely to happen again. I can't foresee the future and can't predict local and global economic catastrophes but again, certainty comes at a cost and it is up to you to decide if that cost is worth it based on your circumstances.

It might be an idea to put the 'penalty' amount that you would pay to fix this risk into your bond instead. You'd be saving in excess of R20 000 per year and that will go some way to assuaging your conscience and your pocket.

Article by: Dave Welmans - (