Fixed vs. Variable Interest Rates: What You Need to Know for Bridging Finance

When you’re looking to secure bridging finance, one of the key decisions you’ll face is whether to opt for a fixed interest rate or a variable interest rate. This choice can significantly impact your repayment amount and overall financial planning, even for a short-term loan like bridging finance. Let’s break down what each option means for you.

Understanding Fixed Interest Rates Rates 🔒

A fixed interest rate is exactly what it sounds like: it’s an interest rate that remains the same for the entire duration of your loan term. This means your repayment amount will be predictable and won’t change, regardless of what happens in the financial markets.

Pros of a Fixed Interest Rate:

• Predictability: Your monthly repayments are set in stone, making it much easier to budget and manage your cash flow. You’ll know exactly how much you owe each month.
• Protection from Rate Hikes: If the South African Reserve Bank’s repo rate increases, your interest rate won’t be affected. You’re shielded from sudden and potentially costly increases in your repayments.
• Simplicity: It’s straightforward and easy to understand. The rate you agree to at the start is the rate you’ll pay until the loan is settled.

Cons of a Fixed Interest Rate:

• Higher Initial Rate: Lenders often charge a premium for the certainty of a fixed rate. This means your initial interest rate might be slightly higher than the starting rate of a variable loan.
• No Benefit from Rate Cuts: If the repo rate decreases, you won’t benefit from lower interest rates. You’ll continue to pay the same agreed-upon rate.

Understanding Variable Interest Rates 📊

A variable interest rate is linked to the prime lending rate, which fluctuates based on the South African Reserve Bank’s repo rate. As the prime rate changes, so will your interest rate and, consequently, your repayment amounts.

Pros of a Variable Interest Rate:

• Lower Initial Rate: Variable rates often start lower than fixed rates, which can make your initial repayments more affordable.
• Potential for Savings: If the repo rate drops, your interest rate will also decrease, leading to lower repayment amounts. This could save you money over the term of your loan.
• Flexibility: It can be an attractive option in a climate where interest rates are expected to fall.

Cons of a Variable Interest Rate:

• Uncertainty: The biggest drawback is the lack of predictability. Your repayment amounts can change, making it more challenging to budget accurately.
• Risk of Rate Increases: If the repo rate goes up, your repayments will increase. This can put a strain on your finances, especially if the increase is significant.

The SARB Repo Rate and Prime Lending Rate

To truly understand variable rates, you need to know about two key terms:

1. The Repo Rate: This is the rate at which the South African Reserve Bank (SARB) lends money to commercial banks. The SARB’s Monetary Policy Committee meets regularly to set this rate, using it as a tool to manage inflation.
2. The Prime Lending Rate: This is the baseline interest rate that commercial banks charge their most creditworthy clients. It is directly based on the repo rate. When the repo rate goes up or down, the prime lending rate follows almost immediately.

Your variable rate loan is quoted as “Prime plus/minus a percentage.” For example, if the prime rate is 11.75% and your rate is “Prime – 0.5%,” your interest rate is 11.25%. If the SARB raises the repo rate and prime moves to 12.25%, your rate automatically becomes 11.75%.

Calculating the Cost: A Bridging Finance Example

Let’s make this tangible. Imagine you need R500,000 in bridging finance for 3 months.

• Scenario A: Fixed Rate
  • You are offered a fixed rate of 15% per annum.
  • The calculation is straightforward. The interest cost will not change.
• Scenario B: Variable Rate
  • You are offered a variable rate of Prime + 3% (assuming Prime is currently 11.75%, your starting rate is 14.75%).
  • Month 1: The rate is 14.75%.
  • Month 2: The SARB announces a 0.25% rate hike. Prime moves to 12%, and your rate is now 15%.
  • Month 3: The rate remains 15%.

In this scenario, the variable rate started cheaper but ended up costing slightly more due to the rate hike. For short-term bridging finance, the risk of a rate change is lower than for a 20-year mortgage, but it’s still a real possibility.

Hybrid and Capped Rates

While less common for short-term finance, it’s good to be aware of other options:

• Hybrid Rate: This loan starts with a fixed rate for an initial period (e.g., the first year) and then converts to a variable rate for the remainder of the term.
• Capped Rate: This is a variable rate that comes with a “ceiling.” Your rate can fluctuate but will never go above a pre-agreed maximum, offering a blend of flexibility and protection.

Which is Right for Your Bridging Finance?

Given the typically short duration of bridging finance (1-6 months), the choice often comes down to your personal risk tolerance.

• Choose a fixed rate if: You prioritise budget certainty and want to eliminate all risk of rising costs. This is the most common and often recommended choice for the peace of mind it provides during a transitional period like selling a property.
• Choose a variable rate if: You have a higher risk tolerance, the starting rate is significantly more attractive, and you are comfortable with the possibility of a rate fluctuation. This could be beneficial in a clear rate-cutting cycle, but it remains a gamble.

Before you decide, always ask your lender to provide clear cost estimates for both options so you can make a fully informed decision.