Fixed-interest rates not always viable fix

05 July 2017

With the South African economy reeling partly from the aftershocks of a surprise cabinet reshuffle earlier this year, homeowners are "understandably concerned about the effect the devaluing rand will have on bond interest rates", says Marc Hendricks, regional manager for Rawson Finance in the Western Cape.

The prime lending rate, steady at 10.50% since March last year, may start a significant upward trend and this could put mortgage holders under serious financial pressure to meet their increasing monthly bond repayments, he adds.

In situations like this, it's not uncommon for homeowners to negotiate with their bank to fix their interest rate for a certain length of time, hoping this will protect them from future rate increases.

Unfortunately, says Hendricks, fixed interest rates are not the lifeline they may seem in times like these.

"Because fixed rates do not fluctuate with the prime lending rate, banks hedge their bets so they don't lose money if prime climbs higher than expected," he says.

"Fixed rates are always higher than variable rates to adequately offset the bank's increased risk. The greater the risk, the greater the gap between variable and fixed rates and the less viable as an option for cash-strapped consumers."

Hendricks recently received quotes from one bank for fixed rates between 0.59% and 0.84% above the variable rate, depending on the length of the fixed term, which can be 12, 24, 36, 48 or 60 months.

While this may not seem like a big premium for knowing exactly how much you'll need to pay into your loan over the coming months, adding context places things in a different light.

"These fixed rates are based on the customer's current variable rate and not prime.

"Don't think you're going to pay prime plus 0.59%. We've had customers quoted variable rates as high as 5% above prime recently, which makes it possible those fixed rates could work out to 16% or 17%.

"To fix your rates that high means you're stuck there for the full fixed-rate period, whereas variable rates can be reassessed on request and lowered if your risk profile or payment record improves."

Bondholders with variable rates that are already relatively low might find the fixed rate offer tempting, but Hendricks is dubious about the benefits.

"I wouldn't be surprised to see banks insisting on reassessing a customer's variable rate before quoting a fixed rate," he says, "which means you may be forced to give up your lower variable rate as part of fixed-rate negotiations. That may not be a problem during the fixedrate term " although it does mean your fixed rate will be higher than expected" but when that period concludes, you automatically revert to your reassessed variable rate, which would then be much higher."

Hendricks says banks will never make an offer they believe will leave them short.

"If a bank offers a fixed rate 0.59% higher than what you're currently paying, they're either confident prime won't rise more than that within your fixed-rate period, or they are sure your variable rate is already high enough to provide an adequate buffer."

Of course, there's always the chance the bank underestimates how high interest rates may rise.

"That's the gamble," says Hendricks. "If you know something your bank doesn't, fixing your interest rate may be a great idea, but few of us have the experience or access to information that the banks do when it comes to financial forecasting."

A wiser course of action, Hendricks advises, is to try to improve your credit rating and risk profile and consolidate your debt as far as possible. This may make it possible to negotiate a lower variable rate that will save you more in the long term

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