Should you choose a fixed or variable bond payment option?

The pros and cons of fixed bond and variable bond payments.

When you apply for a mortgage bond you will usually be asked whether you would like a facility with a variable interest rate or would prefer the rate to be fixed. There are pros and cons to both options, and your choice will depend on your personal circumstances.

Variable bonds

Variable rate bonds (variable bonds) are the most common, with the interest rate the bank charges you being linked to the prime lending rate. This means that if the prime rate goes up your monthly repayments increase, and if the prime rate goes down your repayments will decrease. A mortgage bond with a variable interest rate is granted at the prime rate plus or minus the number of percentage points indicated by your overall credit rating. If your personal credit risk profile is in the excellent category, you could be granted a variable bond at less than prime.

A variable interest rate minimises the risk for lenders, so they usually 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.

Because variable bonds fluctuate in line with the prime rate they are affected by macro-economic factors like the rate of economic growth, the inflation rate, the rand exchange rate, variations in gross domestic product (GDP), the petrol price and global factors like the Covid-19 pandemic.

Fixed bonds

With a fixed bond the interest you are charged each month is set for a certain period - usually two years. Fixed bonds are not linked to the prime lending rate. In this case the rate the bank quotes you will apply to your home loan and your monthly bond payments will be fixed for a set period, regardless of what changes the SA Reserve Bank makes to the repo rate, which in turn governs the prime rate. So, if prime goes up during the term of your fixed bond, the effects will be cushioned. You will continue to pay the same amount of interest on your loan and your monthly payments will remain the same.

The advantage of this type of loan is that it enables 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.

This means you will get no benefit if interest rates should drop before the end of your fixed bond period. To benefit financially, you would need the prime interest rate to increase by more than 2% very early in the life of your fixed bond loan.

Another downside of fixed bonds is that they're only offered for a maximum of 60 months, whereas most home loans have a total term of 20 to 30 years. At the end of the fixed rate period, you'll have to renegotiate with your bank for a new fixed rate bond for another set period, or a variable rate which may be at a higher rate than you would have paid initially.

In conclusion

If you're 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 five years - a fixed bond may be the right option for you. Do keep in mind, though, that a fixed bond will not only increase your minimum monthly instalment but also increase 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 the SA Reserve Bank's Monetary Policy Committee's April repo rate meeting, the bank forecast an average headline consumer price inflation of 3.6% for 2020. The overall risks to the inflation outlook at this time appear to be to the downside, the SARB statement said. This gives the bank space for further cuts in the near future, indicating that variable bonds are best for now.