Real Estate Investor Magazine South Africa October 2014 | Page 34

FINANCES

BY JOHN LOOS

Interest Rate:
Fix or Float?
Can you beat the market?

A

fter a long period of “abnormally low” interest
rates brought about by the global economic
crisis, the Reserve Bank’s (SARB) Monetary
Policy Committee (MPC) has raised the interest rate
twice this year, increasing it by 0.75 percentage points.
At the most recent September MPC meeting, the
interest rates were kept stable. Nevertheless, Reserve
Bank Governor Gill Marcus has forewarned the South
African public that we are currently in an increasing
rate cycle and consumers should expect to see further
rate hikes in the future. It has been forecasted that
the MPC will likely only recommence with moderate
hikes in 2015. Economists predict at least a 100-basis
point hike, likely to be introduced in small increments
of around 25-basis points over the next few quarters.
The purpose of fixing rates
There is no right or wrong when it comes to fixing
rates, but it is important to consider some important
factors.
Firstly, fixed interest rates should not be seen as a
way to “beat the market”. They are there for greater
cash flow certainty in an uncertain world.
Fixed interest rates exist precisely because future
moves in interest rates are uncertain. Fixed rates are a
service provided by banks, enabling the client to shift
the cash-flow risk involved with fluctuating interest
rates onto the bank for a certain period. The bank
assumes and manages the interest rate risk, and the
client obtains certainty over the interest rate payment
portion of their cash flows. In return for this benefit,
the customer can expect to pay some price.
Should floating rates over the period in question
average a rate lower than the level of the fixed interest
rate for the period, then the client would have been
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better off (but only with hindsight of course) leaving
his/her interest rate to float. Conversely, if the SARB
were to “shock” us with interest rate hiking, and the
average floating rate over the period is significantly
higher than the client’s average fixed rate, then the
client will be glad he fixed the interest rate.
While some people may want to use fixed rates to
try to “beat the market”, my view is that the decision
to fix or float should rest on how much certainty one
would like over one’s cash flow. For the person that is
keen to avoid risk, even should floating rates average a
lower rate over a specific period than the average fixed
rate that he/she fixed at, the value for this person is
that he/she has cash flow certainty under a fixed rate
arrangement for a defined period.
Conversely, more risk-taking individuals, some of
whom may feel there is a chance of further interest rate
cutting due to an underperforming global and local
economy for some years to come, may feel that they are
losing out on an opportunity by fixing rates.

October 2014 SA Real Estate Investor

Best time to fix interest rates
Timing the interest rate cycle to perfection is always
going to be tough. Traditionally, we find a considerable
increase in fixing of interest rates as the SARB starts to
hike its repo rate. Simplistically, this would seem to be
the logical time to fix one’s interest rates, as history tells
us that when the SARB hikes the repo rate for the first
time there’s usually more hiking to come.
There’s a catch, though. When a client fixes his
interest rates, a bank takes over the risk of interest
rate fluctuations from its client. The bank in turn
will then hedge out its own risk by offloading the
client’s floating rate debt in exchange for a fixed rate
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