Six months ago Barclays Wealth predicted that South African interest rates would increase by 200 basis points by the end of 2012. At that time banks were charging around 115 basis points above their existing rate for clients to fix their mortgage for two years.  Today some banks are offering customers a fixed mortgage for two years at prime – simply because the view on interest rates has changed that dramatically.

Funeka  Ntombela , head of home loans at Standard Bank, says the bank had the opportunity to buy funding in the market which allows them to offer a fixed rate at 9 percent. “We forward bought funds, it may cost us in the short-term but it will pay off in managing our credit risk as it will assist our clients to hedge their interest rates,” says Ntombela who says this funding is only possible because the market effectively believes that interest rates will not be increasing for a while. “This is the first time in a while we have had this opportunity, usually you pay a premium to the prime rate when you fix a mortgage”.

Absa bank is also offering quality clients fixed prime rates. Currently Absa is offering 24 month fixed rates ranging from  9% to 10.8% depending on the risk and the loan balance related to the property value.

Existing FNB customers who want to fix their mortgages for two years will pay a 20 basis point premium on their existing rate and for a 60 month fixed rate they will pay a 110 basis point premium – in May this year that premium was 225 basis points.

Nedbank has the highest premium and is charging an additional 80 basis points to fix your rate for two years and 120 basis points for a three year fixed mortgage compared to FNB’s 50 basis point premium for the same period.

It makes sense for the banks to use this opportunity to grow their home loan books as they are able to lower the risk for their customers by offering aggressively priced fixed rates. House prices have fallen significantly and are close to their bottom, we are at the peak of bad debts and the banks will already know which customers are underwater while new bad debts are in decline. If a bank can offer a customer with a solid credit record a fixed mortgage for two years the bank will effectively have substantially reduced their lending risk as the customer is not exposed to unexpected rate increases.

The question is whether it is worth fixing your home loan at these rates. The answer depends on where interest rates are most likely to move next.

Paul Stewart, MD of Plexus, says the market outlook on interest rates has changed significantly over the last few months and that the forward rate agreement curve is priced downwards. However Stewart believes the likelihood of an interest rate cut is negligible and that the risk is actually for rates to rise.

“We don’t believe that there will be a massive deviation from inflation targeting, one needs to be careful of the assumption that interest rates will be flat for a longer period of time as inflation is a real threat”.  While the argument is that higher interest rates will not affect exogenous price pressures like oil and food prices, Stewart says there are already signs from retailers that they are experiencing cost push inflation which suggests the second round of inflation affects is seeping into the system.

The Reserve Bank has a mandate to maintain price stability. Inflation has already reached the top of the target range and is expected to breach target so a rate cut in this inflation environment where low income earners are already facing an inflation rate of 7.8% would be a significant deviation from the mandate.

If Stewart is correct and the risk to interest rates is on the upside, then fixing your mortgage at prime is a no-brainer, but you may need to move quickly as the banks will re-price depending on the cost of credit. Standard Bank however has bought a significant amount of funding at these levels.

Standard Bank has already contacted 14 000 of its existing home loan customers that it believes would benefit from this opportunity. These are customers whose existing mortgages are around the current prime rate. “It would not benefit a customer who has a rate of 200 basis points below prime,” says Ntombela. The offer is also open to new customers with a good credit record who would qualify for the prime lending rate. Over the last four months Standard Bank has issued R1.35bn of home loans at interest rates of 8.5% and 9%.

This article by Maya Fisher-French first appeared in the Mail&Guardian