To fix or not to fix

As consumers face the onslaught of spiralling inflation and brace for yet another rate hike next week, many homeowners may be considering fixing their home loans. But Mokgatla Madisha, bond analyst at Investec Asset Management, cautions that this may be a costly decision. “You could end up paying more in interest than if you were to ride out the cycle.”

According to Madisha the decision homeowners have to make rests on how much higher interest rates will go and how long they are likely to stay at elevated levels.

“Inflation is rampant and Reserve Bank Governor Tito Mboweni has been clear about his intentions of addressing it aggressively, but homeowners should bear in mind that the higher rates go now, the quicker they are likely to fall. Swift action by the Reserve Bank now will reduce inflation a lot faster. Fixing your rate for two years could mean that you are stuck paying off your mortgage at 16% in 2010 while inflation could have fallen back to 6% and rates have been reduced down to 12%,” Madisha says.

Banks generally offer the opportunity to fix mortgage rates at around 0.5% to 1% above the current prime rate for a period of up to two years. Floating rates are generally anything between 1% to 2% below prime.

To illustrate, a homeowner with a R1 million bond is currently paying back R11 715 per month at prime minus 2%. “He decides to ride out the interest rate cycle. Let’s say rates were hiked by 1% at each MPC meeting in June, August and October, and then stay on hold until May next year. That would take the prime rate up from 15% to 18% and the homeowner’s repayments up to R13 912 a month.”

If a homeowner were to fix his home loan at prime plus 1% now, his monthly repayment would immediately spike to R13 912 per month. “In our hypothetical example, he has to cough up every month what the other homeowner will only start paying in October this year, when interest rates have risen another 3%. Over a full year, he would be paying around R6 000 more!”

According to Madisha, this example suggests a really dire outlook for interest rates. “Investec Asset Management does not foresee another 300 basis points in rate hikes. All things being equal, we anticipate a further 1% to 1.5% rate hike until the cycle peaks, which would mean that the homeowner on a fixed rate is even worse off. He could be stuck for another year at the fixed rate, while those on a floating rate could start enjoying the respite of lower interest rates.”