A relatively new entrant into the home loans space is offering some upside protection to home-owners who believe interest rate hikes aren’t over yet.
The company — Integer — says the product, known as Inter Cap, which launches on August 1 and will only be available to its customers, caps the interest rate for one, two, or three years, but allows clients the flexibility to benefit when the interest rate eventually drops.
Simon Stockley, CEO of Integer, says the capped product has been around for some time now but mainly for commercial investors. It has not been actively marketed to residential borrowers but he believes that current uncertainty about the interest rate environment and real issues about affordability have created a need to make the offering available.
Stockley says the banks won’t launch a similar product because they prefer fixed-rate products over caps. He believes consumers will go for the flexibility that a cap offers, as they will benefit when rates come down. Ultimately, however, whether the product works will depend on consumer demand.
The technicalities
The Inter Cap allows a client to choose the level at which to cap their rate — either at the current bond rate or at an increase of 0,5%, 1%, 1,5% and 2%.
The client chooses the duration of the cap — one, two or three years — and chooses the level at which to cap the rate (for example, for the full bond amount or any other portion, perhaps 50%). The actual cost is determined at the time of the sale and is a function of the yield curve at the time.
Integer amortizes the cost of the cap over the remaining term of the loan, although the client can elect to pay back at whatever rate is affordable. There is an increase in the outstanding capital of the loan due to the cost of the cap being added, which would increase the cost of the overall interest paid on the loan.
Assuming a cap cost of R7 500 that is amortized to the loan, which equates to a R100 repayment over 240 months, the additional amount that would be paid, including interest for the cap, equals R24 310 minus R7 500, which comes to R16 810.
While this cover may only hold for 12 months, it may well be the critical period when the homeowner cannot afford to have his or her bond instalment increase over the cap rate applied for. If this cover was not in place, the danger is that the owner could lose the property and a substantial portion of the capital already invested.
This excludes the cost of starting the home-ownership process from scratch, with transfer fees, agent’s commission and all the other unknown costs that are built into the price of a home.
Stockley was quick to point out that Integer is not recommending that a client borrows the money over 20 years. It encourages clients to pay the cap in cash if they can afford to. On the other hand there is an option if a homeowner doesn’t have the cash readily at hand: the company will re-advance the funds to buy the protection and it is then paid back over whatever period is negotiated. But remember that interest is charged.
House prices drop
The Standard Bank median house price was recorded at -11,3% y/y in June, with the five-month moving average contracting by 7,8%. Demand for mortgages has been in contraction since June 2007, because of a confluence of headwinds confronting the South African consumer, including high interest rates, inflation and the additional hurdles in accessing credit since the implementation of the National Credit Act. Declines in the demand for property of this magnitude and duration are not inconsistent with national house price deflation.