Fixed vs Variable Interest Rate Bonds
Category Market Insight
Understanding property industry jargon can be overwhelming for many first-time homeowners, and feelings of overwhelm increase when applying for a bond. In this blog, FMS Sales & Leasing will attempt to alleviate those feelings by discussing the differences between variable bond and fixed bond payments.
When applying for a bond, the option of a variable or fixed interest rate is usually offered by the financial service provider. Both options have merit, and most likely, the decision will be influenced by personal circumstances.
Variable bonds
Variable-rate bonds (variable bonds) are the most common. The interest rate charged by the bank is linked to the prime lending rate. This means that if the prime rate increases, so do the monthly repayments, and if the prime rate goes down, so do your repayments.
A variable-interest bond is issued at the prime rate plus or minus the amount of percentage points determined by your overall credit score. If the credit risk profile is excellent, the financial service provider may consider a variable bond at a rate lower than prime.
A variable interest rate minimises the risk for lenders. Because of this, they tend to offer applicants a more competitive rate of interest. This can be as much as 2% less than the rate for fixed-rate bonds (fixed bonds) for the same applicant and sometimes even lower.
Variable bonds are impacted by macroeconomic factors because they fluctuate in line with the prime rate. These factors include;
- rate of economic growth
- inflation rate
- rand exchange rate
- variations in gross domestic product (GDP)
- petrol price
- global factors like the Covid-19 pandemic and global currency fluctuations
Fixed bonds
Fixed bonds are not linked to the prime lending rate. With a fixed-rate bond, the interest you pay each month is predetermined for a defined time frame, typically two years. In this case, regardless of changes to the South African Reserve Bank's repo rate, which controls the prime lending rate, the monthly bond repayment will remain constant for the specified time period. The benefit of a fixed bond is that if the prime lending rate goes up during the fixed term of the bond, the effects will be cushioned. The interest and the monthly repayment will remain the same.
This type of loan has the advantage of allowing you to budget with certainty. However, the big disadvantage is that the interest rate charged is typically around 2% or even higher than with variable bonds to start off with. A disadvantage of a fixed bond is that it is typically charged at around 2% or higher than a variable bond.
An easier explanation is that, if interest rates decline before the end of your fixed bond period, you will not benefit from it. To benefit financially, the prime interest rate must rise by more than 2% early in the life of your fixed-rate loan.
Another disadvantage of fixed bonds is their limited loan repayment period. They are usually only available for a maximum of 60 months, whereas most home loans are available for 20 to 30 years. At the end of the fixed-rate period, you must renegotiate with your bank for a new fixed-rate bond for another set period or a variable rate that may be higher than the initial rate.
Overall, the decision of which bond option to opt for, depends on personal circumstance, an understanding of finances, and potentially even the property market. A fixed bond may be a suitable option during times of financial uncertainty. However, keep in mind that a fixed bond will increase not only your minimum monthly instalment but also the total amount of interest payable on your home over the life of your bond.
If your goal is to pay the least possible amount of interest on your bond in the long run, a variable interest rate will almost certainly be your best option.
At FMS Sales & Leasing the property journey is about feeling at home. Whether you're a first time buyer or seasoned landlord, the Cape Town property market moves in ways that can be difficult to predict. We believe that perfecting the core fundamentals of accurate pricing, client relationship building, and a hyperlocal approach is what gives us the edge in today's crowded real estate market. We are able to advise you on the best possible solutions for you and your property.
Contact FMS Sales & Leasing today
Author: FMS Sales and Leasing
