We reckon the crystal ball shops must be all sold out. Everyone’s trying to see into the future, so they can figure out how long to re-fix their home loan for. Putting a foot wrong could cost thousands, either in extra interest paid or in break fees.
Flexibility or certainty – what’s best for you?
If your home loan is coming off fixed soon, do you re-fix for just one or two years? Or should you fix for a longer term – maybe even five years? Or is floating a sensible option? At this point in the interest rate cycle, it’s possible your best strategy hinges on having the flexibility to change to a better rate as quickly as possible, which means picking a short term or floating rate. But then again, those five year rates may look tempting. Before you make a decision, it’s best to understand all the factors involved. Here’s our eight-point summary of the current situation.
- Some long term rates are dropping
A glance at the rates page on mortgages.co.nz is always revealing. You can immediately see how all the fix term rates are stacking up and who’s going lower. At the time of writing this article, some lenders are offering a five-year fixed rate that’s slightly lower than the typical one-year rate. That’s an indicator of change coming.
2. We could be near the top of the surge
When short term fixed rates are higher than long term fixed rates, history says we’re nearing the top of the interest rate surge. Tony Alexander and other economists are saying that at some point in the not-too-distant-future, interest rates will start to fall right across the fixed rate spectrum.
3. Peak pessimism may have passed
In his January report, independent economist Tony Alexander said peak pessimism has passed. In November, when the Reserve Bank raised the official cash rate 0.75% (a record), business and consumer confidence took a dive. Kiwis started tightening their belts in preparation for recession. But then a couple of things happened to neutralise pessimism – a downward trend in bank funding costs and a slowing of inflation. All things considered, Tony suggests the future’s looking brighter. Read his full report here.
4. The terrible summer will have an impact on what happens next
Economists are saying the knock-on effects of widespread flooding this summer will likely weaken New Zealand’s economic growth and keep inflation high. However, the Reserve Bank believes its 50-point official cash rate (OCR) hike to 4.75 per cent on 22 February is unlikely to push all mortgage rates higher than where they are now. In a NZ Herald article published on 23 February, CoreLogic’s NZ’s chief property economist Kelvin Davidson agreed with this.
“The good news for stretched borrowers is that the impact of Wednesday’s decision on mortgage rates doesn’t seem likely to be too significant. Floating rates will likely go up again, but only about 10 per cent of loans are on these rates. There may also be a bit of upwards pressure on 1-year fixed rates, but it’s expected to be minimal given further OCR increases had already been ‘priced in’, and banks have actually brought down their longer-term fixes in recent weeks.”
5. A falling interest market fattens up break fees
When you decide to break your fixed rate term before it ends, you might get charged a ‘break fee’. A break fee is a penalty for backing out of an agreement. The size of the fee is based on how much your lender will lose because of your decision to terminate.
If you’ve owned your property for less than 10 years break fees probably haven’t been an issue for you, because New Zealand had a falling interest rate environment. It’s only when interest rates are on the rise, which will happen at some point, that break fees become a big problem. If you have a sizeable loan and want to terminate a fixed rate agreement to jump onto a better deal, you could be looking at a substantial break fee – potentially five figures.
Another sting could be the need to repay a cash incentive or return a reward you received from your lender if you decide to refinance (move to a different lender). Read more about refinancing.
6. A floating rate provides ultimate flexibility
Generally, floating rates are higher than fixed rates so you’ll pay more interest each month. However, floating rates offer total flexibility, so when interest rates are falling you can jump onto an attractive fixed rate whenever you like. Also, in a falling interest rate market floating rates come down so the amount of interest you pay each month will reduce.
Interestingly, you might discover lenders with floating rates that are lower than the floating rates offered by major banks. For example, Heartland Bank has a track record of low floating rates. What’s more, Tony Alexander says that banks are offering discounted fixed rate deals on the quiet.
7. A mix of fixed and floating is a popular strategy
In times of uncertainty, many borrowers put a buck each way to spread their risks. This means splitting your loan into a floating portion and a fixed portion. And some borrowers split their loan into even more portions, with each chunk on a different fixed rate. If you compared this strategy to what happens in the investment market, you’d say it was ‘diversification’ – a way to smooth out the impact of interest rate fluctuations.
8. Getting expert help can mean access to special deals
When you’re trying to formulate a borrowing strategy to minimise the impact of increased interest rates, it helps to touch base with your mortgage adviser. Together you can work out a range of options, then choose the one is best for your situation.
If you don’t have a relationship with a mortgage adviser, now’s a good time to connect to someone you can trust. Mortgage advisers have access to ‘off market deals’ that aren’t advertised. Some examples (on 23 February) include 4.99% for 12 months and 5.99% for periods of 18 to 24 months – plus a 1% cash back. Another lender is accepting applications for low-deposit loans, where the deposit is less than 10% of a property’s valuation. To access deals like these, get our help to find an expert adviser.
