About eight years ago I remember the debate raging about whether or not to fix mortgage rates as interest rates started to climb again.
I have a clear memory of chatting to a bank economist (we won’t mention names) who said to me that we would definitely not see the same 500 basis point interest-rate hike that we had seen at the end of the 1990s. At most we would see a 250 basis point rate hike. Ha!
If there is one thing I have learnt, economists generally underestimate inflation on the way up and overestimate it on the way down. (Interestingly, this is the same pattern we see with company analysts — underestimate earnings on the way up, and overestimate on the way down; no one likes taking real bets).
Last month we saw inflation figures surprise on the upside, and if we have any weakening in the rand, those international food and oil price hikes will hit us hard. Stanlib economist Kevin Lings has calculated that a 10% fall in the rand will push our inflation figure to 6%. The rand can move 10% in a day.
Inflation is back and the probability is that it will be higher than we expect.
The debate, however, is the government’s response — will Reserve Bank Governor Gill Marcus favour growth over inflation? With unemployment figures back at 25%, pressure to stimulate the economy is growing.
As a result, economists differ as to whether we will see an interest-rate hike this year or early next year. One thing they all agree is that there will be a rate hike. Barclays Wealth expects to see a total 200 basis point hike by the end of 2012.
That will in effect increase the interest portion of your mortgage repayments by a massive 24% — that is R1 600 a month on a R1-million mortgage. That is money straight out of your budget that goes into the black hole of interest repayments.
If we see the same inflation cycle of the early 2000s and a similar monetary response from the government, there is no reason why over the next three years we won’t see interest rate hikes of 500 basis points, increasing that R1-million mortgage repayment by R4 160 a month. That is serious money.
So should you be speaking to your bank about fixing your mortgage rate? On the one hand, by fixing your rate you are buying peace of mind and if we see a serious rate hike you will be cushioned from the worst of it. In fact, in 2003 it would have been one of the best financial decisions you could have made.
On the other hand, you start paying for that rate hike before the event, so it costs you money. It really is a bet against the bank.
The smart move
According to FNB, if you fix your mortgage for 12 months you will pay an additional 35 basis points.
If the first rate hike is 50 basis points in November that could be a smart move. If the first hike is only next year, the bank has won.
For 18 months you will pay an additional 70 basis points. Maybe not such a bad option. The first rate hike will put you nearly in the money and if Barclays Wealth’s predictions of 200 basis points is correct, you could be paying 130 basis points less than a prime-linked mortgage for a while.
For 24 months you will pay 115 basis points extra, and if you want to fix your mortgage for five years you will pay an additional 225 basis points. That will actually increase your mortgage by 25%, which is steep but it could pay off if we see sustained higher interest rates until 2016.
But the really smart move is to take the 225 basis point increase the bank would charge you (R1 875 on R1-million) and pay that into your mortgage every month — you will be paying off capital, not interest, so therefore increasing your asset base, not the bank’s.
It will take at least 18 months to two years for actual interest rate hikes to reach that level, and if they surpass it, the equity you have built into your mortgage will give you credibility with the bank if you need to renegotiate.
The worst thing you can do is nothing. Interest rates are going up and you need to bulletproof your finances now.
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