While the drastic interest rate reductions of 2020 have brought with it new financial opportunities, caution should be taken when decisions are made that rely on these lowered rates.
Since January 2020, the interest rate has been cut by 2,5% and currently stands at 3,75%. With such low interest rates, it is understandable that borrowers are looking for ways in which they can take advantage of these historically low rates for the longest possible time. One of the most seemingly viable ways in which to do this is through changing bond payments from variable interest rates to a fixed interest rate. Ideally, this would ensure that you safeguard this historically low interest rate. The truth, though, may in fact not be all that simple.
The first consideration should be the risk factor. Fixed interest repayments do secure a fixed repayment amount, which is better for the borrower’s budget and reduces their risk when interest rates fluctuate. But now, the risk lies solely with the bank. If a major spike in the national interest rate occurs, the bank will be responsible for covering the difference on behalf of the individual.
Banks, however, are aware of this risk and prepare for it by charging an additional premium of between 1,5% and 3% from the get go. This means that borrowers could be charged the prime rate of 7,25%, and up to 8,75%, to secure a fixed interest rate.
This higher rate will lead to a borrower paying R934 extra per month on a R1 million loan, money that will be wasted until the interest rate actually does reach the 8,75% mark again, which it hasn’t in more than a decade. If a borrower does have an additional R934 at their disposal on a monthly basis, it is advised that this money should much rather go towards reducing the capital amount of the bond. When consulting amortisation tables, it is easy to see that putting such payment towards reducing the capital amount could lower a R1 million loan to R R965 000 in a single year, and R928 000 within two.
Another major consideration is the fact that once a fixed rate is applied, borrowers will also lose out on any further interest cuts – a possibility that has already been hinted at. If this does occur, it means borrowers will be paying an even higher percentage interest than they would have under the variable rate. Remaining on a variable interest rate will thus allow borrowers to take advantage of further cuts that may be made to further stimulate economic activity.
Fixed interest rates may seem like the perfect opportunity to grasp at, but upon closer inspection, they may, ironically, actually cause you to miss out on the savings the interest rate cuts intended.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)