Home loans are connected to the prime lending rate which can change when the interest rate is adjusted.
According to Andrea Tucker, director of MortgageMe, when people register their homes they can choose one of two interest rate types - variable or fixed.
It is important that people understand the difference between the two rates. This is so they can choose the rate that ideally suits them which will give them control over their budgets in the future.
Understanding the difference between these two rates will help you to choose the one that best suits you, giving you a modicum of control.
John Manyike, head of Financial Education, at Old Mutual said that homeowners and new home buyers need to look at the pros and cons of choosing a fixed interest rate or a variable interest rate before making a final decision.
Here is a closer look at fixed and variable interest rates:
Variable interest rate
Tucker said that variable interest rates change with the prime lending rate.
“Your home loan agreement will default to a variable interest rate when you’re contracting with a bank to wrap up your home finance,” Tucker said.
For homeowners, this means that when the bank adjusts its prime lending rates in response to a change in the repo rates, then monthly repayments will increase or decrease depending on the change in the rate.
Pro: People could save money on their monthly repayments if the prime lending rate goes down as the monthly instalment is adjusted according to the rate change percentage.
Con: Your monthly instalment will increase which means you will pay more if the prime lending rate goes up.
Fixed interest rate
According to Tucker, a fixed interest rate will remain the same for a specific and agreed period of time.
Tucker said that once a person’s bond has been registered they can apply for a fixed interest rate. However, there is a strict time limit, so people should not take too long before making their decision.
The rate that the banks will offer is dependent on the going rate at the time. Banks will allow you to set your interest rate for a period of 12, 24, 36, 48 or 60 months. Your monthly payment will be fixed for the period you select.
“When the fixed interest rate period has expired, your home loan will automatically revert to a variable interest rate,” Tucker said.
Pro: A fixed interest rate allows people to plan around their home loan repayments because they know exactly how much they will be paying for the period that they choose.
Cons: A fixed interest rate is higher than a variable rate as it poses more of a risk to the bank and if the prime lending rate goes down, your monthly payments will remain the same.
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