When buying a home one has to consider all the important aspects such as the immediate finance and the monthly finance. A big portion of this consideration is your bond, how will – and how long will you be paying it back.
It is known knowledge that paying off your bond as fast as possible are of course the best financial decision you can make. This is especially true in high interest rate countries such as South Africa, when your paying “back interest” are always higher than your “gaining interest”. This is where you need to consider the pros and cons of a fixed interest rate bond.
A fixed interest rate basically means that you and the bank comes to an agreement that you as the bond owner will pay back the bond at an agreed upon interest rate. This agreed upon rate however is usually slightly higher than the current interest rate, usually 1.5-2% above prime. A variable interest rate is just what it states it is, it varies with the natural fluctuation of interest. If the rate goes up, your interest goes up, if the rate goes down your interest goes down. Understanding the difference makes it much easier to determine the correct choice for you.
Pros of Fixed Interest Rates
There are several benefits to a fixed interest rate:
1. You know exactly what you are going to have to pay back every month. This is a great budget benefit for those that buy at their absolute max and that won’t be able to absorb a spike in interest rates.
2. If you believe that the interest rates will increase over the time period of paying back the bond it might be beneficial to take the slight increase in rate now, to save in the long term.
It must be noted that a fixed interest rate is only agreed upon for 5 years, after that you and the bank will have to “renegotiate” a new rate. It is here where the bank will make up their money if they lost any, meaning you made a smart choice fixing your rate originally. My suggestion is if you do consider going for a fixed interest rate (as it seems appealing right now) you should absolutely try and pay back your bond as fast as possible. If you can do it in a matter of 5-7 years then you deserve a golden star.
Cons of Fixed Interest Rates
1. If the interest rate drops, you will still be liable to pay at your agreed upon high rate.
2. You will be paying a higher rate initially, this might however be beneficial in the long term.
3. The agreed rate is only valid for upto 5 years, after that the bank will try and make up any losses they may have incurred.
What to do, this is very difficult question and it is important to ask those around you, to listen to the professionals, but you must also feel like this is the right decision, you are after all the one making those monthly installments.
Property24 has made an excellent example on the type of calculations you should be doing before signing on the dotted line. They make the example on “a R1 million bond, at a 9.25 % interest rate, your monthly repayments over 20 years will be R9 158, and the total you’ll pay back will be R 2 198 080. However, if the interest rate is 9.75 percent, your monthly repayment will be R9 485, and your total repayment over 20 years will be R2 276 440. That’s a total difference of R78 360. So it’s obvious that even a small shift in the interest rate can end up costing homeowners a lot of money.”
My professional opinion (as a graphic designer and future homeowner) is that going with a variable bond is not a bad idea if you don’t buy at your absolute max. (Something you shouldn’t be doing anyway). Also if you were to work on a fixed interest rate and add those few extra hundred rands to your variable bond instalments every month you are working towards paying of your bond faster than the 20 years. However this stays a very difficult decision and there are truly no right and wrong answer here. Some professionals with say go for a fixed rate, others will say you are making a mistake. The gist is that it stays your decision, just do your homework and be happy with your choice, which ever way it goes.