You know how higher interest rates affect you as a consumer
If you have a savings account, you receive more interest; which is good. But if you owe money on a home loan you are charged more interest on your loan, which increases your monthly repayments; not so good.
Ever wondered why the Reserve Bank raises interest rates?
The SARB is tasked with keeping the rate of inflation within certain targets. Inflation is generally considered to be a result of too much money chasing too few goods and with higher loan repayments, people have less money to spend at the end of the month. With less money to spend, demand for goods and services should fall and in turn reduce the excessive inflation rate, achieving the result the SARB intended.
How can you avoid getting caught short by rising home loan repayments?
Many banks offer an option for you to fix the interest rate on your home loan for a pre-determined period – usually from 24 to 60 months. If you had a fixed interest rate agreement with your bank in place before the recent interest rate increases, you will have seen no increase to your home loan repayments.
At times like this, the media is alive with talk of fixed home loan rates to protect you from those increased bond repayments. The motivation for the discussion is usually based on the objective of avoiding the higher interest rate.
Back to the question — to fix or not to fix that interest rate?
The advantage of fixing the rate is certainty. You can be certain of the affordability of your repayment for that particular period. The disadvantage is that the bank will almost always charge you a higher interest rate when you ask for a fixed rate. Therefore, your decision will likely be linked to the extra interest the bank will charge.
The bottom line is that it will generally be cheaper not to fix your interest rate. The reason for this is that the bank will price in expected future interest rate increases in order not to lose money.
So, when is it advisable to fix your interest rates?
Sometimes people extend themselves to the limit of their cash flow to buy a new home, for example when they have children, usually with an expectation of the repayment becoming easily affordable in the future with expected annual pay increases. In cases like this, a fixed rate could be advantageous as you can budget for the repayment cash flow and will not be affected for the initial period when the repayment is stretching your financial capacity.
Bottom line: when you fix interest rates, expect to pay more – because you almost always pay a premium to lock in certainty.
What’s the next step?
Speak to your CERTIFIED FINANCIAL PLANNER® professional about budgeting for your current lifestyle expenses, it’s the first step in creating a strategy for your future investment objectives.
By Ian Beere, CFP® CA(SA)
