June's 200 point hike will hit hard

30 May 2008

Most economists are expecting the SA Reserve Bank to hike rates by a 100 basis points on 12 June, raising the prime interest rate from the current 15% to 16%. However, yesterday Reserve Bank governer Tito Mboweni announced the possibility of a full 200 basis point hike instead. This will not only increase monthly repayments on existing home loans out of the reach of many homeowners but will, of course, also further erode the buying power of new entrants to the market.

Affordability levels have already deteriorated significantly on the back of the nine 50 basis points rate hikes seen since mid-2006. At the time, South African families needed a monthly income of R26 000 to qualify for a mortgage loan to buy the average priced house – R21 500/month or 45% less than what will be needed to buy the average priced home if rates rise by another 200 basis points.

These calculations are based on Absa's house price index, which shows that two years ago (April 2006) the average, mid-sized house cost R789 000. At the then prime interest rate of 10,5% the monthly repayment on a 100% mortgage over 20 years amounted to R7 875.

Taking the traditional mortgage repayment ratio of 30% of gross household income into account a monthly income of around R26 000/month would have been required back then to qualify for the R789 000 loan.

Absa's latest figures show that the price tag of the average house in SA rose to R974 000 in April 2008. If prime reaches 17%, monthly mortgage repayments would jump to R14 286. That would mean that SA homebuyers could soon need a monthly income of around R47 500 to afford the average priced house (30% of R47 500 = R14 250).

Admittedly, the introduction of the National Credit Act in June 2007 means that banks no longer use the 30% flat rate as the only criteria to determine how much homebuyers can borrow. Disposable income now also comes into play. Even so, it remains a useful benchmark to determine how affordability levels have changed.

The affordability picture looks equally bleak for existing homeowners if rates should indeed rise by a further 200 basis points in June. Monthly repayments will rise by around R150 for every R100 000 owed. In other words, homeowners with an R1m bond will see repayments surge by another R1500/month. That would bring the total increase in repayments on an R1m mortgage over the past two years close to R5 500/month.

The question arises whether it makes sense to opt for a fixed interest rate contract now before next month's rate decision. Fixed rates currently on offer by most banks seem relatively attractive with discounts of up to 1,6% below prime (15%) available, depending on the size of the loan and loan-to-value ratio.

Gavin Opperman, Group Executive of Secured Lending at Absa Retail Bank, says there is no doubt that fixed rates are still a viable option for consumers who want to manage cash flow and mitigate the risk of further rate hikes. - Joan Muller

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