So, you\u2019ve found a property you love, sent in your bond applications, and the banks have finally started responding with offers. But, one of the offers has two interest rates quoted: a fixed and a variable.<\/p>\n
Rawson Finance explains what that means, and which one should you choose.<\/p>\n
Variable rate bonds<\/strong><\/p>\n \u201cVariable rate bonds are the most common,\u201d said Leonard Kondowe, national admin hub manager for Rawson Finance. \u201cThey\u2019re called variable because the interest rate the bank quotes you is linked to the prime lending rate. That means if prime goes up your repayments go up, and if prime goes down your repayments go down too.\u201d<\/p>\n A typical example of a mortgage bond with a variable rate would be granted at prime plus or prime minus dependent on applicants’ overall credit score.<\/p>\n According to Kondowe, a variable interest rate minimises the risk for lenders, which means they can usually offer applicants a more competitive deal. For this reason, variable interest rates are often as much as 2% lower than fixed rate equivalents, if not more.<\/p>\n \u201cDepending on your personal risk profile, it\u2019s definitely possible to get a variable bond at less than prime, but that\u2019s virtually unheard of for fixed rate mortgages,\u201d he said.<\/p>\n Fixed rate bonds<\/strong><\/p>\n Unlike variable rate mortgages, a fixed rate bond is not linked to prime. That means the rate the bank quotes you is exactly what you\u2019ll pay, regardless of what happens SARB’s repo rate.<\/p>\n \u201cA fixed rate bond is quoted as a specific percentage \u2013 say 12%,\u201d said Kondowe. \u201cIf prime goes up during the term of your fixed rate, it makes no difference \u2013 you\u2019ll still pay exactly 12% interest on your loan. That can be very reassuring for homeowners who are at the upper limit of their affordability and are expecting prime rate to be revised upwards.\u201d<\/p>\n Unfortunately, since fixed rates are typically around 2% or even higher than variable rates to start off with, bondholders would need the prime interest rate to increase by more than 2% very early on in their fixed rate period to benefit financially.<\/p>\n \u201cIt\u2019s rare for interest rates to increase more than one percent in a year these days,\u201d said Kondowe. \u201cIn fact, the biggest fluctuation in prime that we\u2019ve seen since 2016 has been 0.25%. That means bondholders opting for a fixed rate are very unlikely to recoup the cost of their higher repayments, even if prime does start increasing faster than before.\u201d<\/p>\n Another downside of fixed rates is that they\u2019re only offered for relatively short terms \u2013 a maximum of 60 months, as opposed to your bond\u2019s total term of 20 or 30 years. At the end of this period, you\u2019ll either revert to your originally-quoted variable rate or have to renegotiate with your bank for a new fixed rate offer.<\/p>\n \u201cLimiting the term of a fixed rate is one way that banks minimise the potential impact of any prime interest rate fluctuations,\u201d said Kondowe. \u201cIt allows them to address any shortfalls if they happened to underestimate how fast interest rates would be adjusted upwards before they eat into their bottom line.\u201d<\/p>\n Which is the better choice?<\/strong><\/p>\n According to Kondowe, if your goal is to pay the least possible amount of interest on your bond in the long-run, a variable interest rate is always going to be your best bet.<\/p>\n However, if you\u2019re facing uncertain financial times and are willing to pay a little extra for the security of knowing exactly what you owe each month (for up to 5 years), a fixed rate may be the option for you.<\/p>\n \u201cKeep in mind, a lot depends on your personal situation and risk profile,\u201d said Kondowe. \u201cWhat makes sense for one bondholder may be a terrible idea for another. If you\u2019re not sure what to do, I\u2019d always recommend talking to a bond originator. We\u2019re very happy to share our experience and advice to help you choose the most appropriate finance option for your needs.\u201d<\/p>\n
\n