Fix or float?

Private Property South Africa
Anna-Marie Smith

Last week’s hike of the prime interest rate to 9.5% coincides with predictions of an upward curve into 2015.

This, along with related “upside risks” such as growing inflation, is enough to heed the words of economists: you can’t beat the market. They strongly advocate that uncertainty is best remedied through risk aversion and strict fiscal discipline.

Banks say that fixing the interest on your bond over a set period, although at a price, can offer an ideal solution especially amid ongoing rate increases following the SA Reserve Bank’s decision to “normalise” low-level interest. At the same time, floating or variable interest may pose additional savings, albeit over the long-term only, to smart investors who are able to wait for the downturn.

Check the trends

It would make Rands and sense then, to check for up and downward trends before either locking yourself in, or to prevent increased risk during volatile economic patterns. Says First National Bank’s John Loos: “Fixed interest rates are a tool offered precisely because of future uncertainty”. Depending on your personal finance habits and sufficient knowledge gained from industry professionals, fixing is a risk averting action that brings peace of mind. This however, says Loos comes at the cost of banks taking over the risks associated with interest fluctuations, from their clients.

This method, which allows newcomers to enter the market as conservatively as possible, also prevents them from racking up poor credit records during tough times. Defaulting remains one of the biggest and costliest headaches, both to borrowers and lenders. This can be averted by paying a slightly higher rate than prime over an agreed period, in return for surety against the unknown.

Floating rates

The benefits of floating rates, on the other hand, which were exercised conservatively through a lack of choice, were part of a personal first home ownership experience during the early 1990s. This period coincided with the impact of various local and global economic factors that drove prime to an all-time high of 27% before the SA Reserve Bank intervened. Industry advice to opt for floating rates, that although a true test of time to most first-time homeowners who by then were honouring crippling bond repayments, became an ideal savings tool after good habits had been formed.

A fixed rate at the time would have escalated bond repayments by at least another percentage point. And so, when interest came plummeting down after sitting it out through tough times, there was every reason to continue with the same re-payments, which helped reduce the capital value of bonds, sooner than expected.

Cash-flow certainty

Loos says that bond holders can also achieve greater cash-flow certainty by living within their means. This would then allow them to set monthly bond repayments above the minimum requirement of the bank, so as to benefit from the lessened effects on their monthly cash flow should interest rates be hiked. And in the case of an unexpected windfall, such as a bonus, tax refund or inheritance, he says “these days many bonds have no penalties for early settlement”.

The ability to use fixed interest rates for a more secure cash-flow, rather than to “beat the market”, brings greater certainty in an uncertain world.


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