Fixed vs variable interest rates

Repo rate and prime interest rate

Firstly, the prime interest or lending rate serves as a basis for determining the rate that a lender will offer to a prospective client. The prime interest rate is also linked to the repo rate which serves as a benchmark for the interest rate at which the South African Reserve Bank lends money to other banks. As the Reserve bank adjusts the repo rate, this affects the prime lending rate to either go up or down.

What is a variable interest rate?

The most common selection when it comes to mortgage loan interest rates is a variable interest rate linked to prime. This means that the interest rate granted to you by the bank will fluctuate along with the prime lending rate, meaning if prime increases, then so will your loan interest rate.

Should the South African Reserve Bank decide to adjust the repo rate, the prime lending rate will adjust accordingly and this will have a knock on effect to your interest rate and therefore your monthly repayment amount. As such, homeowners with the variable interest rate option should closely monitor changes in the repo and prime lending rates. This will help in staying up to date on their monthly repayment amount and ensuring there are sufficient funds in their transactional account to cover these costs.

What is a fixed interest rate?

Unlike a variable interest rate, a fixed interest rate is not linked to the prime lending rate. Accordingly if a rate was fixed at 11.5%, repayments are calculated at that specific percentage for the duration of the fixed period agreed upon. This means that regardless of fluctuations in the repo rate and prime lending rate, your home loan remains unchanged and your monthly repayments remain consistent.

Banks typically offer a fixed rate for a specific period after which you can elect to reinstate the fixed rate or revert to a variable rate depending on the agreement between the homeowner and the bank.

What is better: fixed or variable mortgage?

The advantage of a variable interest rate is that should the prime interest rate decrease, so too would your monthly loan repayments, offering a financial respite. Of course, there is the converse risk should prime increase. Since there is less risk to the lending institution with this type interest option, you are likely to get a more favourable rate at the time of lending.

When it comes to fixed rates, while they are typically higher than variable rates, they offer a level of financial security since you can be easily calculate your loan repayments will be each month and plan your finances accurately. Since a fixed interest rate is not affected by fluctuations in the market, a homeowner with a fixed interest rate does not run the risk of being negatively affected by an increase in the repo rate. However, he or she will also not benefit should it decrease.

As with many situations, choosing the right option for you will depend heavily on your personal circumstances and your specific context. A qualified financial advisor can assist is assessing your financial situation and choosing the option that will best suit your affordability.

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Written by Wessel de Kock

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