A variable interest rate mortgage is typically a mortgage with a clause that gives the lender (a bank or other lending institution) the right to vary the payable interest rate as it sees fit, from time to time, without consulting the borrower (the new homeowner or real estate investor). If all goes well, this means that the borrower pays less interest when the market conditions dictate lower interest rates, but pays more interest if the market dictates higher interest rates.
But can the borrower always trust the lender to be fair and equitable with the increases and decreases in the payable interest rate? Lenders are in the business of lending to make a profit after all, and a big profit is always better than a small one!
Mortgage Contracts
The interest rate payable by the borrower on any loan amount must be included in the lending agreement, including a "home loan" or another loan for the purchase of real estate. If the payable interest rate were not stipulated in the loan agreement, it would be like asking for a dispute to occur.
A loan agreement, as any other contract, is a meeting of the minds of two or more parties. All the material terms of an agreement must be either made clear in the contract, or be reasonably determinable. But if an interest rate is not mentioned, what would be seen as the determinable interest rate that is payable by the borrower? Or if a mortgage contract does stipulate an interest rate to start from, but gives one party the right to change the interest rate as it sees fit, does it constitute a binding agreement?
Are Variable Rate Mortgage Contracts Binding?
There used to be a debate in legal circles on whether or not a bank may include a clause in a mortgage bond conferring on it the right to unilaterally increase the original rate of interest from time to time. A lot of uncertainty used to surround the matter, especially given the conflicting judgments in South African courts on this point. But this uncertainty was recently wiped away.
The Supreme Court of Appeal put an end to any uncertainty by finally ruling that a clause in a mortgage bond giving a lender the right to unilaterally increase the original rate of interest from time to time is valid and enforceable. The judgement is qualified though. Such variable interest rate clause is only valid and enforceable if the lender exercises its right reasonably and in good faith.
In other words, a bondholder cannot increase the interest rate out of all proportion, without taking prevailing market conditions and the interest rates charged by other banks into account.
Variable Interest Rates Vary
Interest rates have recently fallen to twenty year lows, much to the delight of homeowners, homebuyers and real estate agents alike.
Lower interest rates mean that homeowners with variable interest rate mortgages pay less for their monthly mortgage repayments, or that potential buyers will be able to pay more for their property. Homebuyers are able to qualify for larger home loans. And real estate agents usually have an easier job finding buyers with the means to purchase property.
So, everybody smiles in the real estate industry when interest rates are low, right?
Bad Things Do Happen
One wonders how short many South Africans' memories are. Every day, South African buyers choose to buy properties of the highest possible value they can afford, leaving no margin for the possibility of future interest rate increases.
Can South Africans not remember only a few years ago, when many South African homeowners were hard hit by sudden increases in interest rates? Or are we so arrogant as to believe that bad things cannot happen to us?
Property buyers should take care, and real estate agents must guard against luring unsophisticated buyers into believing that rates will drop further or that they will remain at present levels indefinitely.
Interest rates will almost certainly rise again, especially in a developing country such as South Africa. And when that happens, buyers must realise that the payable interest rate, in terms of their mortgage bonds, will be adjusted upwardly. Homeowners will not be able to claim that banks don't have the right to do so. On this point, the law is now absolutely clear.
Plan For Interest Rate Variations
A variable interest rate mortgage places a big responsibility on the borrower - To PLAN for foreseeable and unforeseeable interest rate increases. If interest rates go skyward for any reason, the borrower must have the financial resources to service the mortgage debt.
If this responsibility is too much for prospective homebuyers, they should rather opt for a fixed interest rate mortgage.
