Fixed Interest Rates – Beneficial Or Not?

Rob Lawrence*
16 May 2010

Rob Lawrence tells us why it is not a wise step.

If, for whatever reason, it is important to bondholders to be able to budget ahead with complete accuracy, it could be a good idea to fix the interest rate on their bonds for a stipulated period – but for most of us this is not a wise step to take as it will almost certainly result in our paying anything up to 4% more than the market rate over the one to ten year periods for which fixed rates are usually granted.

Taking as an example, a loan of above 80% on a sum above R500 000 that ABSA could insist on a 14.2% interest rate. Although the banks are open to negotiation, this could mean that for anything up to ten years the bondholder would be paying up to 4.2% above the current rate.

If the fixed rate was for five years the rate would be 13.5% – 3.5% above the 10% present rate – and on loans smaller than R500 000, the rates would be even higher.

A simple arithmetical calculation will show that with a bond like the one mentioned, rates would have to move up at least 4% within two years for it to become beneficial for a bondholder to have a fixed rate.

The bondholder would really only benefit in the last year of the bond.

In all likelihood, he added, the bond rate will not jump 4% overnight and the sequential rate rise from 10% (current prime) to 14%, if it happens, will take a lengthy period of time. The fixed rate option is therefore even less attractive.

Most people, said Lawrence, now think that the rates will not start rising again for at least another 12 months – and there could even be a further 0,5% drop in the next few months before this happens.

With the banks becoming a little more relaxed in their bond lending now is the time to get a bond at or below prime. For those buying in the affordable market, fixed rates will, however, remain obligatory.

*Rob Lawrence is the national manager of Rawson Finance

Article Source: Realestateweb

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