To fix or not to fix

There are a number of options for those concerned by a rising interest rate scenario.

How will home owners be affected by the Reserve Bank's monetary policy committee decision last week to increase the repo rate (the rate at which the Bank lends to commercial banks)?

Though the rise of 50 basis points, initially, may not have much effect on those who haven't stretched themselves to the limit, a rising interest rate environment will. Absa senior economist Jacques du Toit believes that "if current inflationary pressures, and other negative factors, persist in the second half of the year, it is quite possible that interest rates may increase further before the end of the year".

Interest rates have been falling since June 2002, with the last rate decrease in April last year.

Nedbank home loans MD June Tudhope says people who have recently taken out a home loan may find some difficulty making their monthly repayments, particularly if they have stretched themselves. Speculators who have taken a home loan may find themselves having to sell.

Standard Bank's director of home loans, Leon Barnard, sees the home loan market being affected should interest rates rise 2%. "But higher interest rates as well as higher rates and taxes in certain areas should slow down growth in the property market," says Barnard.

However, with current indicators pointing to an upward trend in rates, bondholders need to decide what to do.

One of the options for those who take the view that interest rates will rise is to fix their loan for a period. "If you expect the interest rate cycle to change, it is probably a good idea to secure the rate you pay," Barnard says. "You will pay a bit of a premium but it will give some comfort that your repayments won't become unaffordably high."

Tudhope suggests that people who are at their limit may want to fix the rate. "But it depends on your view on the interest rate cycle," she says.

Fixing the interest rate paid comes at a price. The initial interest rate is higher than the current variable rate, but once rates begin to rise, the client scores as his rate stays fixed. Interest rates can be fixed for different periods, usually between one and five years, depending on the bank. The fixed rate option is usually only cost effective if it is taken for a year or more. After the time period has lapsed, the customer goes back to a variable interest rate.

However, should a customer decide to switch back to variable before the time period is up, there is usually a fixed cost involved which is multiplied by the number of months remaining.

Another option which a customer can choose is a "flexible payment term". If the usual repayment term of 20 years is extended to 30 years, the monthly repayments fall. Barnard says this amount could be up to 10%. "But it is not advisable to use the entire 30 years to pay off the bond, as the interest paid over this period will be substantially more than that paid over 20 years."

Barnard advises holders of home loans to repay their short-term debts and new property owners not to extend themselves to their limits.

With current indicators pointing to a rising interest rate environment, mortgage advance growth is expected to slow, thus affecting banks, which have been operating in a buoyant and competitive environment. Du Toit expects current growth of 30,1% year-on-year to slow in the second half of the year to between 20% and 24%.

Banks are already making small margins off their home loan book, so low-risk customers probably won't be able to demand interest rates less than the current lowest offerings of 2%-2,5% below prime. However, some customers may not be able to repay their home loans, resulting in more bad debts.

Tudhope says there are signs of higher bad debts in credit cards and vehicle finance. "That is usually the first sign of difficulties, as people usually make their home loan payments first."

Banks can offer "repayment holidays" for short periods. Barnard says people should talk to their bank to discuss the options available.

Article by: Heather Formby - www.sundaytimes.co.za