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Fixed or variable rate home loans? No simple answer.
Correction
We start this issue with two corrections to our May issue, in which we discussed transfer duty:
- We incorrectly used the general term "transfer costs" when talking about transfer duty as a specific tax. Transfer costs are much broader and include more than just transfer duty.
- The statement "If the property costs between R 500 001 and R1 000 000, R25 000 transfer duty is payable" was incorrect. The transfer duty is actually 5% of the amount of the purchase price between R500 000 and 1 000 000. Therefore, if the house costs R510 000, the transfer duty will be R500 (5% of R10 000). A transfer duty of R25 000 would only be payable on a house that costs R1 000 000 (5% of R500 000).
We apologise for the inaccuracies and regret any confusion caused.
Wading through the choices: Fixed or variable interest rate?
When it comes to buying property, the choices can be staggering – and we're not just talking about whether you like your floors in Oregon pine or Italian tile.
We're talking about issues with far greater implications, such as: Should I fix the interest rate on my home loan, or leave it variable? Would it be cheaper to buy a plot and build my own house on it? What about buying a fixer-upper and renovating it instead of buying something brand new?
Unfortunately none of these questions come with a simple answer, and the answers all depend on your budget and your tolerance for stress! In this article we're going to focus on the first question: Should I opt for a fixed or a variable interest rate on my home loan?
We wish we could answer this question simply, but unfortunately there is no easy "yes" or "no". Instead, there are some factors to consider, and our aim in this article is to present you with those factors, which will help you make a decision that works for you.
Firstly, a bit of background. In the May 2006 issue of Money Matters we looked at the interest rate and the effect it has on your finances. Here is an extract:
"The South African Reserve Bank lends money to commercial banks, who then lend it on to their clients. The repo rate is the ‘price' that the commercial banks pay to the Reserve Bank for the privilege to borrow money and lend it on to their own clients at a higher price.
For various economic reasons, the SARB increases or decreases the repo rate from time to time. The repo rate is the most important indicator for short-term interest rates. If the repo rate increases, it means the banks need to increase their interest rates, which means that people with overdrafts, for example, will pay more interest. Conversely, if the repo rate decreases, banks will decrease their interest rates."
The point we made was that the repo rate fluctuates, and therefore, so do interest rates.
For example, just a couple of weeks ago, in early June, the repo rate increased by 50 basis points, which meant that banks had to increase their interest rates by 50 basis points. The rate hike is the fifth in a year, and has taken the prime rate of lending from 10,5% to 13%.
This latest half a percentage point increase means that for a person with a R500 000 standard variable-rate home loan at prime over 20 years, the monthly bond repayment will increase from R5681 to R5858 – an extra R177 to pay each month. For a person with a fixed-rate home loan, the monthly bond repayment will not increase at all. With a fixed-rate home loan you basically fix the interest rate that you pay on your home loan for a specified period of time, normally 12, 18 or 24 months. But you are contractually bound to this rate during this time period, and you won't enjoy the benefit of a lower rate, should interest rates drop. At the end of the contract term, you can choose to fix your rate again or switch to a variable-rate agreement.
Unfortunately it is difficult to predict what will happen to the interest rate. Even economists are sometimes surprised to see it rise. You can't make a decision about a fixed-rate or variable-rate home loan based on what might or might not happen to the interest rate, because you'll just be guessing.
So how do you decide? Here's a simple guideline: A fixed-rate home loan might suit you if your budget is very tight right now and you need the guarantee of knowing your home loan repayment will remain exactly the same every month for a certain time period (e.g. 24 months).
It will also suit you if the idea of rising interest rates makes you nervous, and you know your budget would not withstand an increase to 25% as happened in 1998. On the other hand, if you have room in your budget to accommodate interest rate increases, and you'd like to benefit from possible reductions in the interest rate, then a variable-rate home loan would suit you.
This is a decision that is unique to each person's financial situation. Talk it through with your bank – they are equipped to guide their customers to a decision.
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