Real Estate Investor Magazine South Africa October 2014 | Page 35

RESIDENTIAL

debt instrument (negotiable certificates of deposit or
bankers acceptances, for example) in what is called a
swap, for the duration of the fixed rate term that the
bank has offered its client. In practice, this gets done
in bulk deals by the bank’s treasury division. The price
and interest rates at which banks can obtain such fixed
interest debt instruments (and thus the fixed rate
which they can offer their clients) is determined by
future interest rate expectations of the market.
Like the individual, the money market also often
expects more rate hiking to come when interest rates
first start rising (and for a major part of the hiking
phase). If the market expects more interest rate hikes
during a SARB hiking phase, then the rate which the
banks can pass on to their client can appear somewhat
unattractive.
The converse also holds true. Fixed rates on offer start
becoming more attractive when market expectation of
future interest rates has moved lower, and can remain
fairly attractive during periods where interest rates
have reached the bottom of a cycle (always impossible
to know for sure if that stage has been reached) but
the market doesn’t yet expect interest rate hiking for a
significant time period.
When the SARB has already started hiking interest
rates, one is unlikely to obtain the most attractive fixed
interest rates. Rather, it is often in times of interest
rate cutting or in periods of low sideways movement
in interest rates, prior to widespread expectation of
imminent rate hikes, that the better fixed rate deals are
probably going to be found.
The better option
A great way to increase certainty regarding repayment
cash flows is to set the monthly repayment significantly
above the required monthly payment, which would
imply that up until a certain magnitude of rate hikes
one’s monthly payments would not change, thereby
improving cash flow certainty (though obviously not
eliminating it entirely). These days, many bonds have
no penalties for early settlement.
How much in the way of interest rate hiking
should one make provision for? That is impossible to
say for sure, but if one uses the past two interest rate
hiking cycles as a benchmark, the prime rate rose by 4
percentage points to 17% in 2002, and by 5 percentage
points to 15.5% in 2008.
Another option
Another alternative is to raise the monthly instalment
annually by a certain percentage, for instance by the
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CPI (Consumer Price Index) inflation rate. This would
mean that, as the years go by, one would gradually
adjust one’s lif