Author: Matthew Davidse
Once you’ve successfully applied for finance to assist you in purchasing a property you love, one of life’s biggest financial commitments would then be to enter into a home loan agreement with your chosen bank accordingly.
Understanding what concepts such as variable or fixed interest mean in relation to a home loan, and how the repo rate and prime interest rate can affect your monthly repayments becomes important. Here’s what you should know.
What is the repo rate and prime interest rate?
Firstly, the prime interest rate (“prime”) refers to the base rate that a commercial bank uses when determining the interest rate to be offered to their clients (in this case, a prospective homeowner) at any given time.
It is, in turn, informed and driven by the repo rate which is determined by the South African Reserve Bank (“Reserve Bank”). The repo rate refers to the interest rate that commercial banks pay on money lent to them by the Reserve Bank.
Basically, the repo rate dictates how expensive it is for a bank to lend money from the Reserve Bank and consequently, how high the interest rate on a home loan would be to a homeowner.
Whether you receive an above or below-prime loan would be dependent on your affordability and credit risk profile, amongst other factors as determined by the bank.
Variable-Rate Home Loans
By far the most common interest rate offered by banks on a home loan is a variable interest rate, which is related to prime.
Should the repo rate be increased by the Reserve Bank it would have the knock-on effect of increasing the prime interest rate, which in turn means a higher monthly bond payment for a homeowner. This is because the interest rate applicable to the home loan will increase accordingly, by virtue of it being variable.
It also means that if the prime rate decreases due to market fluctuations informing the repo rate, a homeowner’s monthly bond payments will also go down.
Should you be successful in applying for a home loan, by default, a variable interest rate will be offered by the bank. Thus, after your mortgage bond has been registered in the Deeds Office, you as the homeowner can apply with the relevant bank to have the interest rate on your home loan fixed.
Fixed-rate Home Loans
A fixed interest rate refers to an interest rate which is not affected by prime.
It should be noted that should an interest rate be fixed, it would usually be higher than the applicable variable interest rate which was offered to the homeowner initially. This is because the bank has to adequately manage its risk for the specified agreed period that the interest rate is fixed for.
The homeowner would therefore pay monthly bond payments based on a fixed interest rate for a specified period of time, as per their agreement with the bank.
A fixed interest rate is also not offered for the full duration of the home loan but rather for a short term which is agreed to by both the homeowner and the bank.
Typically, a bank will fix the interest rate for a maximum period of 5 years or 60 months. Thus, once the initially agreed period has expired wherein the interest rate was fixed, the remaining period of the home loan and the monthly repayments thereon would again be based on a variable interest rate – as linked to prime; unless the homeowner is successful in their application to have the interest rate fixed for another specified period with the bank.
Should you fix the interest rate on your home loan?
It stands to reason that if you elect to fix your home loan’s interest rate it would bring a certain sense of financial security, as for a specified period, your monthly bond repayments would not be affected should the repo rate increase, thus remaining stable and predictable. Conversely, this also means that should the repo rate decrease, you will not be able to share in the savings during the specified period that your interest rate is fixed.
The benefit of a variable interest rate is therefore that your monthly repayments would decrease should the repo rate decrease. Further, should your credit risk profile improve during the term of your home loan, you can request that your bank re-assess the variable interest rate applicable to you. Naturally, the downside to a variable interest rate is should the repo rate increase, your monthly bond repayments will increase as well.
The answer as to whether you should fix the interest rate applicable to your loan would be based on your financial circumstances, risk profile and specific personal context. It would therefore be prudent to seek the advice of a certified financial planner who could help you determine whether the option of a variable or fixed interest rate would best suit your financial needs.