1. Coventional Mortgage Rate Versus Jibar Rate
2. Fixed and Variable Mortgage Rates
3. House Prices
4. Investment Opportunities Exist In Listed Property
5. Home Rentals Set To Rise
Coventional Mortgage Rate Versus Jibar Rate - Denise Simpson
Historically, the majority of home loan finance in South Africa has been provided by the major 4 retail banks, but over the past few years new players have entered the mortgage lending market. Home buyers now have more choices of who to use to finance the property they have chosen to purchase. The competition is good for the market and the healthy margins enjoyed by the banks are a thing of the past.
The major retail banks use a prime-based rate when establishing interest rates for consumers seeking mortgage finance. Prime is the individual bank's lending rate, and this rate is in turn influenced by the REPO rate.
The REPO rate is set by the South African Reserve Bank, and is used by the Reserve Bank to regulate consumer spending and to ensure that inflation is kept in check. When there is an increase or a decrease in interest rates, it is the result of the Reserve Bank adjusting this REPO rate. The REPO rate also sets the rate at which the banks can borrow wholesale funds from the South African Reserve Bank. Prime is therefore a managed rate or a discretionary rate determined by the bank, but always influenced by changes in the REPO rate.
The non-traditional lenders that have entered into the mortgage lending market do their sums very differently and raise capital to lend to home buyers by the method of securitisation. Put simply, they originate a bundle of home loans and sell them off to an investor who is looking for a reliable long-term investment. They calculate their rates using the 'Jibar'. The Jibar is an independent market-derived rate for terms of one, three, six and 12 month money market deposits determined by the ten major South African financial institutions, and is released by the South African Futures Exchange.
Both the REPO rate and the Jibar have been consistent for many years and they move either up or down in concert. The Jibar rate is reviewed quarterly while the REPO rate is decided by the Reserve bank in meetings, which happen every six weeks.
The non-traditional home loan or 'securitised home loan', does have some advantages especially for smaller value home loans where the rates can be far more attractive. In some cases, a conventional home loan from a retail bank could even be more than the prime rate. It is for this reason that this form of home loan is gaining popularity and has a definite place in the market. What the home buyer must understand is that the interest rate is reviewed quarterly, on both new and existing loans, so the rate quoted when you purchased the property may not be so competitive a year down the road and will definitely vary from time to time.
Access facilities
Access facilities are also available on both conventional and securitised products, but with 'securitisation' it is not client activated any re-advances or withdrawals from the loan have to be applied for. This makes the conventional banks access facilities far more convenient and you can access your funds from your bond account by simply logging onto your bank's website, visiting a local branch or even using an ATM.
Fixing your rate
In uncertain times like the present when rates seem to have moved into an upward cycle, buyers like to take advantage of a fixed rate to reduce the risk of spiraling house repayments. Both conventional and securitised home loan products do offer the facility to fix, and the securitised product does provide for a rate fixed over the entire period of the bond. The rate, however, is high and is dependant on the risk associated to both the client and the equity that the buyer has in the property. The conventional home loan products only offer fixed rates of 12, 18 and 24 months, but the fixed rate is considerably lower than the 20 year securitised product. Like the Securitised product, this rate is invariably higher than the prevailing bond rate at the time.
While the rate quoted by the 'securitisation' lender may seem much lower than the prime rate of your retail bank, it is important to understand that all the commercial banks offer discounted rates on prime. This rate depends on many factors and not all clients will enjoy the same discount.
As mentioned before, rate should not be the only consideration when shopping for a home loan - the parcel of products and services provided by your bank also needs to be considered.
Fixed and Variable Mortgage Rates - Jacques du Toit
Jacques du Toit, Senior Property Economist of the Absa Group looks at the advantages and disadvantages of fixed versus variable interest rates and the factors that would influence the decision to fix the rate or not.
Interest rates were recently increased in South Africa, for the first time since September 2002. This caused the cost of servicing debt, especially mortgage debt, to increase. As a result of this development and consumers' experience in the past regarding rising interest rates, it is appropriate to consider issues such as the difference between fixed and variable rates, the advantages and disadvantages of fixed and variable rates and whether or not to fix the interest rate on a mortgage at this point in time.
The difference between fixed and variable mortgage rates
Fixed mortgage rate
A fixed mortgage rate agreement is a legally binding contract between
a financial institution and a client that guarantees a fixed rate of interest
over a pre-determined period. The agreement may not be terminated prior
to the expiry of the contracted term of the agreement. The implication
of withdrawing from the contract before the expiry date is the payment
of a penalty fee, which is stipulated in the agreement.
Currently, South African commercial banks offer clients fixed mortgage rates for periods of 12, 18 or 24 months. The level of the fixed rate varies according to the period over which it is fixed, as well as the loan amount and the loan-to-value ratio.
Variable mortgage rate
Commercial banks' variable lending rates to the public normally fluctuate
in line with the central bank's key policy interest rate.
Adjustments to South African commercial banks' variable lending rates (the prime and mortgage rates) normally take place after the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) has announced a change to its key policy interest rate, the repurchase (repo) rate.
Although this has not always been the case in the past, the current convention among the South African commercial banks is to adjust their variable lending rates by the same margin as the adjustment in the repo rate. As a result, the margin between the repo rate and variable lending rates such as the prime and mortgage rates has remained stable at 3,5 percentage points since the late 1990s.
The advantages and disadvantages of fixed and variable mortgage rates
Fixed mortgage rate
- Advantages: A fixed mortgage rate will not increase when other interest rates rise. This gives peace of mind with regard to future mortgage repayments. It allows the client to plan and budget more accurately and facilitates future cash flow management. Clients may revert to the variable rate after the fixed-rate contract has expired, or may decide on a new fixed-rate contract, depending on their personal financial circumstances and views of the future interest rate cycle.
- Disadvantages: A fixed mortgage rate may well be above the variable rate for the full term of the fixed-rate contract. The gap between fixed and variables rates may widen if variable rates fall during the term of a fixed-rate contract. Clients are locked in for the full term of a fixed-rate contract.
Variable mortgage rate
- Advantages: Clients get the immediate and full benefit of a cut in interest rates, while they may at any time switch to a fixed-rate contract in an attempt to hedge interest rate risk. Under certain conditions and terms, clients may gain a rate concession (negotiate a mortgage rate lower than the prevailing variable rate, depending on certain terms and conditions).
- Disadvantages: Clients feel the immediate and full impact of any increase in interest rates. Sharp increases in interest rates may affect clients' ability to repay mortgage loans to such an extent that the financial institution has no other option but to repossess the properties concerned because instalments are not being paid. However, this is normally the last option, as such actions benefit neither the client nor the financial institution.
The various options currently available with regard to fixed and variable mortgage rates have increased the flexibility of managing the repayments on a mortgage loan to a large extent. Clients can take market conditions and interest rate expectations into account in their choice of a mortgage rate.
Whether or not to fix a mortgage rate
The decision whether or not to fix the interest rate on a mortgage loan will depend on the following factors:
- Macroeconomic conditions and their possible impact on the interest rate cycle. Factors such as inflationary pressures, growth in credit extension, the level of household debt, currency movements, and the condition of the balance of payments (which will depend on the balance on the current account and capital flows) may influence the central bank's monetary policy stance (the direction of interest rates, as well as the magnitude and duration of interest rate adjustments).
- Consumers' personal financial circumstances. Interest rates may be at a historical low at any given point in time, but if consumers have the view that rates will increase for any reason in the near future, they may elect to switch to a fixed rate, especially if they have a fixed level of income and strict control over cash flow is important to them.
- Timing. The timing of the decision to fix a mortgage rate can be of great importance. The best time to fix an interest rate is as near as possible to the time when rates are expected to start increasing (the bottom of the interest rate cycle). If rates are expected to increase only in twelve months time, it may be expensive to fix the rate too early at a level that is above the variable rate at the time. However, if you wait too long before fixing your mortgage rate and interest rates increase, the eventual fixed rate may be higher than what you would have paid if you fixed the rate at a somewhat earlier stage.
Mortgage interest rate trends and developments
During 1998, when the prime interest rate was hiked to a record level of 25,5% and variable mortgage interest rates increased to 23,5%, fixed-rate mortgages became more common in South Africa. This development gave huge support to many households that were struggling with significantly higher debt repayments, helping them to survive the adverse effects of extremely high interest rates at the time.
Inflationary pressures currently present in the economy, high growth in credit extension and household debt, as well as a deteriorating current account on the balance of payments, prompted the SARB to lift the repo rate by 50 basis points to 7,5% in June this year. As a result, commercial banks increased their prime lending and variable mortgage rates by the same margin to 11% shortly afterwards.
It is at times like these that many consumers, in view of their debt commitments, become uncertain about the future trend and level of interest rates and consider reverting to a fixed rate on their mortgage loans in an attempt to minimise the risk of sharply higher interest rates.
Because financial institutions have to take most of the risk of fixed-rate mortgages, as well as the history with regard to interest rate fluctuations in South Africa, the maximum period over which a fixed rate on a mortgage loan is offered by South African commercial banks is 24 months.
However, households are also required to take on some of the risk by having to pay a higher fixed rate than the prevailing variable rate, depending on the loan amount, the loan-to-value ratio and the period of the fixed-rate contract.
Current projections are for domestic interest rates to increase somewhat further over the next twelve months, but to remain low by historical standards.
To summarise, fixed and variable mortgage interest rates have both advantages and disadvantages. The decision to fix or not to fix rests entirely with consumers. This decision will depend on consumers' personal financial position, trends and developments regarding various macroeconomic and other external factors which may impact on interest rates and, ultimately, consumers' view of the timing, magnitude and frequency of future interest rate adjustments. Consumers' decisions will also be influenced by expectations regarding the duration of any upward or downward adjustment in interest rates.
The slowdown in the housing market is now clearly entrenched, with a persistent deceleration in the growth of house prices.
In June, house prices grew by 6.5% y/y - the lowest since January 2003. Although the monthly numbers, like most economic indicators, are inherently volatile, this corroborates the slowdown in consumer activity reflected in other indicators such as retail and car sales. This slowdown is expected to be aggravated by the moderate rise in interest rates. House prices are expected to consolidate at their current, elevated levels, which should still imply a reasonable average growth for the year, albeit sharply lower than before.
Last year, South Africa experienced the highest house price growth in the world according to The Economist. Following such rapid growth, and in the absence of fresh stimulus following, amongst other supportive factors, the earlier 6,5 percentage points drop in interest rates, a slowdown is to be expected. Far from a boom-bust scenario, South Africa's property market, albeit losing the vigorous pace it enjoyed over previous years, has entered a more stable period. Other countries, such as Australia, the United Kingdom and the United States, also appear to have escaped a rapid decline in house price growth and instead are experiencing gradual slowdowns.
The deceleration in house price growth is more than a loss of momentum and absence of fresh stimulus. Consumers' ability to pay higher house prices are constrained by rising interest rates and the combined impact of sharp rises in petrol and food prices, which limits further house price growth. Furthermore, deteriorating prospects for capital gains, alongside a moderation in rental growth, have been reducing the allure of the property market for investors. This significantly dampens the demand for residential property and consequently reduces the pressure on house prices.
In other words, the sharp decline in house price growth measured in June therefore reflects both an underlying trend and some short-term volatility inherent in the data. For a proper interpretation of the data, it is therefore important to understand how house price indices are constructed.
Unpacking the Standard Bank House Price Index
Constructing house price indices is notoriously difficult. Apart from the challenges that are generally faced when constructing indices, measuring house prices is complicated by the fact that the available data usually stem from the properties sold during a particular period, rather than from a well-designed sample that is representative of all houses. This is aggravated by the heterogeneity of houses. This means that the data need to be interpreted carefully, as changes in the measured prices may be due to:
- actual changes in the general price level;
- changes in the distribution of the houses being sold, for example more sales of luxury houses, may push up the measured house prices even without changes in general prices; or
- the changes may simply be random.
Furthermore, national data from the Deeds Office are available only with a relatively long lag of up to nine months, so current indicators of the housing market are usually based on a particular institution's experience. In this report, data from the Deeds Office are used wherever possible, and are supplemented by data from mortgages granted by Standard Bank, which has a market share of about 25.4% of all new mortgages registered. The data from these two sources are generally highly correlated. Nevertheless, it should be kept in mind that the data are representative of Standard Bank's client base, and may therefore differ from the data of other institutions.
Standard Bank's House Price Index is based on the median price of all houses mortgaged by Standard Bank. The median house price is one of the most common measurements used globally to calculate house price indices. The unsmoothed data are presented to prevent the choice of smoothing technique from influencing the results, and also to prevent the smoothing from masking incipient trends that might be meaningful, such as the pick-up in house price growth following the 50 basis point interest rate cut in 2005. Nevertheless, a 5-month moving average is added to the graphs to highlight the general trends.
In June, the median house price grew by 6.5% from the year before. The deceleration in house price growth corroborates the slowdown in consumer activity reflected in indicators such as retail and car sales. Furthermore, the relatively low growth in June could be at least partly attributed to the increased number of relatively affordable houses being sold. For example, up to April, sales of houses costing less than R500 000 declined as a proportion of total sales. In May and June, however, sales of houses in this price class rose relative to total sales. With relatively more houses being sold for prices below the average and median, both measures would have been pulled downwards.
This might have been a result of the noticeable reduction in transfer duties on houses priced below R500 000 from 1 March 2006, but also of the Financial Sector Charter-related increase in transactions in "affordable" housing . Even though the transfer duty cost declined across the price spectrum, houses sold for less than R500 000 benefited (as a percentage of the price) relatively more. The increase in the volume of transactions at the lower end of the price spectrum also explains why the growth in mortgage advances still exceeds the growth in house prices. But even here an imminent slowdown is already reflected by the month-on-month growth rates, in which the turning point will precede that in the year-on-year growth rates. (Total mortgage advances would also be boosted by an increase in further advances on existing mortgage loans.)
The bottom line
The domestic property boom coincided with a global increase in property values and a very benign macro financial setting. The deterioration in households' financial situations on the back of record-high indebtedness, a record-low savings rate, record-high petrol prices and rising interest rates will constrain further growth in the short term.
Investment Opportunities Exist In Listed Property
Listed property stocks have plummeted since the market peak and more than half have lost a fifth of their value.
Property analysts reckon market sentiment and panic over interest rate hikes have caused distress selling and advise investors not to worry.
The market peaked on May 11, the day the JSE All-Share hit an all-time high of 22 094 points and analysts and investors use the date as a reference point. The interest rate hike of June 8 aggravated the slump. While share prices have fallen, rentals and income of property companies are hardly affected.
It is good to anticipate that the market can soften, says Ndabe Mkhize, analyst at Coronation.
“If the market becomes oversold, resulting in spot prices being lower than fair property values, then astute long-term investors will have rich pickings.”
The property fundamentals haven’t changed, maintains Mkhize.
Given the current fundamentals and factoring in fair bond yields when valuing listed property, I believe the market has over-reacted to the expected interest rate hikes, he explains.
“To be fair, listed property was looking a bit expensive and prices needed to come down, but perhaps it was a bit overdone.”
Rental growth is strong and demand for space is pushing vacancies down, says Mkhize.
He explained to Moneyweb the fundamentals that are putting upward pressure on rentals:
- Escalating building costs.
- Breakeven rentals (the rent the owner of the building must charge in order to make the investment breakeven) are higher than market rentals. This could provide an upward pressure on rentals upon renewal, especially in the office sector.
- Falling vacancies, particularly evident in the office sector.
- Scarcity of industrial land. There is practically no space available in Cape Town, Durban and Gauteng.
- Zoned and serviced industrial space is scare.
- Growth of retail spend. Retail spend is not growing as fast as before but it is still growing. Besides, turnover rentals tend to account for only 3-5% of rental income.
At one stage in recent weeks, 22% was knocked off values in the listed property market, but those who took the full impact have more to gain by sitting tight than moving out, says Mariette Warner, head of property funds at Stanlib.
She explains: “Sitting tight is a smart move when a sell-off has been overdone. It’s too late now to head for the exits. The major damage started after May 10 when the flight from the category began.
“When a market loses a fifth of its value in a few days, there are usually bargain opportunities in the immediate aftermath.”
Mkhize reckons there has been a fair amount of distress selling by lay investors and such a precipitous sell-off is a signals a buying opportunity.
According to Stanlib’s listed property specialist, the suspicion that good value now exists in listed property was confirmed in early July when signs of institutional buying became apparent. - Moneyweb
Home Rentals Set To Rise – Finance 24
Johannesburg - Letting agents are already reporting increased demand for rental accommodation on the back of the recent two half-percentage-point interest rate increases, which could see the market revert back to the traditional 10%/year rental escalations sooner rather than later.
Few buy-to-let investors have been able to pass the standard 10% rental increases on to tenants when leases came up for renewal, as an oversupply of rental properties kept a tight lid on rental growth.
However, the fortunes of buy-to-let investors are likely to change for the better over the next few months as affordability issues force potential homeowners to put buying plans on hold, says Jack Trevena, MD of home loan originator BondExcel.
Overextended investors are also expected to offload some of their properties, decreasing the current rental oversupply.
Trevena says that should provide much-needed support for residential rental yields. Most buy-to-let investors have seen rental yields halve over the past three years, with average net rentals currently at around 6% of market values.
Neville Schaefer, CEO of national letting agents Trafalgar, echoes the same sentiment. He says recent rate hikes are no doubt encouraging more people into rented accommodation, either due to an inability to cover mortgage repayments or because of the security offered by a fixed-term lease agreement.
Schaefer expects rentals to start rising faster than house prices in the next year as the property boom continues to slow. That means income yields will start to grow beyond their current average of around 6%/year.
