Choosing between a fixed-rate bond and a variable rate (or sliding rate) bond is a question that vexes many would-be homeowners, and it’s no wonder. After all, your house will be one of if not the most significant purchase of your life, so it’s important to give this question the attention it deserves.
It boils down to deciding whether you should fix your interest rate when you take out a bond. It’s easy to see why this is so important – with a fixed rate bond, you benefit if rates go up as you won’t be affected; equally, you may find yourself living with regrets should interest rates go down. On the other hand, a variable rate bond will look like a great idea if rates are falling, but less so if they start to go up.
Two kinds of rates – what’s the difference?
As you start researching your bond options, you’ll come across references to the “repo rate” and the “prime lending rate”. The repo rate is set by the South African Reserve Bank – it’s the rate at which they lend to commercial banks such as FNB or Absa. The prime lending rate is the rate at which these commercial banks then lend to consumers (including homebuyers). The prime lending rate will always be the higher of the two, as the banks need to cover their costs and try to make a profit.
The prime lending rate – that is, the banks’ general lending rate – is currently 7.75% and has been rising recently. However, this may not be the rate that you are offered as this will depend on a variety of factors including your credit score. Depending on how you score, you may be offered a rate such as “prime plus two” or “prime minus one” – that is, the current prime lending rate plus 2% or minus 1%. If you’re a first-time buyer, you’ll most likely be offered a “prime plus” rate.
Don’t accept the first offer you get!
Competition between the banks means that it’s definitely worth shopping around. You can do this yourself, or get a bond origination company to do it for you. Once you receive approval in principle, you can go back to your own bank and see if they can match or even better it. Even a slight difference in the rate can make a big difference to how much you pay over time, so always ask the question!
What are your options when you buy a house?
Essentially, you can choose between a fixed rate or a variable rate bond – but what do these mean? With a fixed-rate mortgage, your interest rate is fixed for an initial period – typically five years. It’s important to note however that it’s not fixed for the entire life of the bond. Once the initial period expires, you will need to renegotiate the rate with your bank.
With a fixed-rate bond, your interest rate during this initial period will often be a “prime plus” due to the difficulty of predicting how interest rates might change during the next few years. With a variable rate bond, on the other hand, the interest rate fluctuates in line with the prime lending rate and may go up or down.
But can you afford it?
Whichever option looks better to you, it’s important to do your budgeting and work out how much you can afford in bond repayments each month, and how you would cope if they went up. The numbers may help you decide between a fixed and variable rate bond.
Pros and cons of a fixed rate bond
During the initial period, you’re protected against any increases in the prime lending rate – but you won’t benefit should the rate go down. A fixed-rate bond means that you’ll pay out the same amount each month, which can be helpful when it comes to planning your monthly budget.
Disadvantages of a fixed rate bond include the fact that you can only apply for a fixed rate after your bond has been registered. As banks tend to see this as a riskier option, rates are likely to be higher than with a variable rate bond. Also, as mentioned earlier, you can only have a fixed interest rate for a certain period of time. After this, you will need to renegotiate (or you can choose to switch to a variable rate bond).
Pros and cons of a variable rate bond
With this type of bond, you could be offered a lower rate – and it could get lower still if the prime lending rate falls. However, the reverse is also true: if the prime lending rate goes up, so will your monthly bond repayments. This uncertainty can make it hard to budget, as any changes are typically 0.25% or 0.50% in either direction. While this may not sound like a lot, it could make a significant difference.
If rates go down, one option is to still pay the amount you were previously paying, so that you can pay off your bond sooner. However, given that most bond payments are by direct debit, this may not be easy to arrange.
Expert advice from Reeflords
Most of our homeowners opt for a variable rate bond, but our advice would be to look at fixed-rate options and decide for yourself once you get a decision from your bank. Remember that events on a global scale, such as the COVID-19 pandemic or the conflict in Ukraine, can impact interest rates. Current events are creating inflationary pressures in many countries, including South Africa, and this could well lead to an increase in interest rates as central banks look to combat inflation.
If you have questions about any of the topics discussed in this blog, email terry@reeflords.co.za or connect with us on our Facebook and LinkedIn pages – Reeflords Property Development. We’ll get back to you as soon as we can. Think Home, Think Reeflords.
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