The repo rate hike by 25 bps to 4% in January was not unanticipated. Economists have commented that a gradual rise in the repo rate is necessary to keep inflation expectations anchored and that they predict rates to rise again in March. Further hikes of 25 bps are expected every quarter from now until the second quarter of 2023, ultimately reaching 5.25%. As a result, homeowners may want to consider fixing their home loan interest rate instead of keeping the standard variable rate, says Nondumiso Ncapai, Absa’s Head of Product: Home Loans.
It’s important to understand the terminology and the pros and cons of variable and fixed interest rates before making a decision.
LISTEN - BOND INTEREST RATES - TO FIX OR NOT | EP 427
Repo Rate'
The repo rate is how the South African Reserve Bank charges commercial banks. Interest is a fee the bank charges for lending consumers money and is based on what we call an interest rate. Interest rates are generally determined by the repo rate.
Prime lending rate
The ‘prime’ lending rate refers to the interest rate that banks charge their most creditworthy customers. They are at liberty to determine what rate a home loan applicant or customer is given, dependent on a number of risk factors. “Banks arrive at the individual rate after performing an affordability assessment, which is a requirement as laid out in the National Credit Act,” says Ncapai.
“To qualify for the most favourable rate, banks take into account income, actual expenses, credit record, current credit exposure, the term of the loan, amount of loan required, the property that is to be mortgaged, and whether a deposit is paid on the property.”
Fixed interest rate
This means the interest rate on your home loan will not change over a specified period, usually from 12-60 months.
Variable interest rate
The interest rate on the loan will change every time the South African Reserve Bank raises or decreases the repo rate. The variable interest rate is the default option for Absa’s home loans.
Fixed vs Variable - Pro’s and Con’s
“The biggest advantage of fixing the rate is that it allows one to plan with clear knowledge of your loan repayments for a set period, regardless of fluctuations in the prime lending rate,” says Ncapai. “However, we recommend that our customers thoroughly investigate their options, both fixed and variable, in the context of their personal needs and also take into account the market conditions.”
For example, since the onset of Covid-19, when the lowest interest rate in decades manifested, improved mortgage affordability stimulated the demand for housing. It paved the way for new customers to purchase a first home or additional properties. There was also much movement in terms of up- and down-sizing properties and the ability to afford renovations. But it must be understood that the low interest rate was not sustainable for the economy, which is why, as we recover from Covid-19 impacts, the government needs to bring the interest rate in line with economic recovery expectations.
Inflation, currency and other hikes
Some of the factors influencing the financial markets include producer price inflation (PPI), which is on the increase. Inflation is the decline of purchasing power of a currency over time, meaning that it may require more currency to buy the same amount of goods and services than in the past. PPI measures the change in the prices of goods before they reach consumers.
Consumer price inflation or index (CPI) is, on the other hand, somewhat subdued, currently at around 5%. The CPI measures monthly changes in prices for a basket or range of consumer products and can be used effectively as a cost-of-living index. It is considered a barometer of overall economic health.
“We are also contending with load shedding that has a dampening effect on recovery, and fuel hikes could see the CPI inflation rising even higher than the average 5%,” says Ncapai.
The status quo of the property market
“What is really interesting to note is that regardless of the economic indicators, over the past six months, the number of customers paying their home loan on time has improved, and we see a rapid return to pre-pandemic levels in this regard. However, the potential increases in interest rates will create stress for consumers, which may result in possible increases in repayment defaulters.”
Pressure to re-budget
To avoid this stress, Absa offers a range of solutions to support consumers. “We will do everything possible to work with customers in financial distress and have a number of solutions packages that can assist,” says Ncapai. “This includes examining the possibility of fixing the home loan for a set period and other personalised credit solutions.”
To prepare for future interest rate hikes, Ncapai explains that reviewing the bond holder’s budget is crucial. “There has to be sufficient surplus to accommodate the increases, bearing in mind that this will directly impact an increase in the home loan monthly repayment. If you note that analysts predict a quarterly 25 bps hike between now and into next year, you can anticipate what your repayment will look like over that period of time.
Ncapai also recommends that keeping expenses to a minimum and reducing credit in preparation, will allow a homeowner to rework a budget to accommodate the interest rate hikes. “The most crucial aspect of this is to ensure that throughout the forthcoming months, your credit score is not negatively impacted.
“The sooner you can reach out to Absa consultants for guidance, the more likely it is that you can find a workable solution that will help stabilise your financial health,” continues Ncapai. “We want our homeowners to keep their homes, to ensure they have an asset that adds value and does not become a burden.”
