For those wanting certainty on how much they will pay for their home loan over the next few years, fixing the interest rate on it may be an option. However, First National Bank (FNB) has just pointed out that fixing interest rates on your home loan requires a carefully laid out strategy.
When fixing the interest rate on a home loan, banks do not use the current repo rate, but rather the market interest rate curves (which are constantly changing) to determine which rate to set it at.
“The market interest rates are as dynamic as the share market, meaning that market interest rates rise and fall continuously as new information becomes available to market participants,” revealed Tommy Nel, head of credit at FNB Home Loans.
This means that a customer could end up paying above repo rate if they decide to fix their home loan. However, even if the repo rate is higher than the fixed interest rate at the time that it is set, if the repo rate drops, your fixed interest rate will remain the same for the agreed upon period.
The rate at which a bank will fix also depends on the period of time the customer chooses. You can fix your rate in South Africa for up to five years.”
How to approach fixing your home loan
“Consumers should look at a fixed rate offering more like they would look at insurance products, such as buying protection or insurance against future hikes in the market. I would also advocate against trying to time the market but rather work out your household exposure to rising interest rates,” said Nel.
According to Nel, when deciding if you should fix your home loan rate, you should apply a stress test to your budget. “Stress testing your budget is fairly simple and will give you a good idea where the breaking point is when it comes to interest rate hikes.”
In order to stress test your budget you will need to use bank statements to work out an accurate budget. “Work in contingent expenses such as funds for a car, holiday expenses or any type of non-regular expenses,” said FNB.
“Once you have a solid budget, you will need to ascertain each expense that is affected by a repo rate increase,” revealed Nel.
These expenses will include your home loan, car repayments, overdraft interest and credit card debt. Once you have determined what these expenses are, FNB suggested testing how much your repayments would increase for every one percent increase in the prime rate of interest.
According to Nel, by doing this, you will better be able to see “at what level of interest rate increase shortfalls begins to materialise in your budget,” thus helping you decide whether or not you should fix your interest rate.
“A key part of implementing this strategy is thinking about it in terms of risk management and a decision to protect yourself from losing your property. There is always a possibility that some customers might end up paying a little more than what they would have on a variable rate loan, but it may well be worth it from a risk management and peace of mind perspective,” added Nel.