Mortgages: Should you fix or float?

What’s the smartest way to get the best bang for your mortgage buck?

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Competition for your mortgage moolah is hot. Mortgage rates are the lowest we’ve seen in years, with some banks going even lower than 4%. What’s the smartest way to get the best bang for your mortgage buck?

In November last year, Kiwis owed more than $260 billion on their mortgages. More than 80% was in fixed-rate mortgages (where the interest rate is set for a specific period), with the other 20% on a floating rate (where the interest rate can go up or down at any time).

Nearly 60% of the value of mortgages held by people who are owner-occupiers is due to come off a fixed-rate in one year or less. This means a lot of households will need to make the fix-or-float decision.

Pros and cons

The main advantage of a fixed-rate is repayment certainty. For a set period, you’ll know exactly what your payments will be. This makes budgeting easier and if rates rise, you won’t be affected.

Their downside is you can’t opt out of your fixed term – unless you pay a break fee, which could negate any potential savings. This also means if interest rates drop, you’ll miss out.

In addition, some banks charge a penalty if you make extra repayments during the fixed-rate period.

Floating-rate mortgages offer greater flexibility. If you come into some extra cash, such as an inheritance or work bonus, you can put it towards your mortgage without being stung by fees. However, you’re at the mercy of interest rate fluctuations – great if they go down, not so great when they go up! This can make it more difficult to budget, as your repayments may vary.

Which is cheaper?

We all want to pay the least interest possible on our mortgage so, pros and cons aside, which option consistently produces the lowest interest rates?

Floating rates are related to short-term wholesale interest rates while fixed-term rates, such as the two-year rate, are related to the two-year swap rate, said Professor David Tripe, Massey University school of economics and finance head.

“This means two consecutive two-year fixed rates should work out more or less the same as a four-year rate and it wouldn’t make much difference if you fixed or floated,” he said.

However, Prof Tripe said the reality is different. “In New Zealand, banks compete more vigorously for fixed-rate loans because they can rely on keeping the fixed-rate business until the end of the term. Floating rates can be repaid at any time, which increases the risks for the bank managing its funding.”

We can all breathe a sigh of relief we’re not rewinding the clock back 10 years. Between May and August 2008, the floating rate peaked at 10.72%. On a $300,000 mortgage you would have been paying more than $32,000 each year in interest. Fixed rates were slightly cheaper, but the one-, two- and five-year rates were all, on average, above 9%.

Fast forward 10 years and the floating rate is 5.77% (a more manageable $17,300 a year in interest on a $300,000 loan) and the one-year rate had dropped to 4.75%.

But what does this mean over the life of your mortgage? We looked at historical standard mortgage rates to find out.

Standard mortgage rates

Download this table in PDF format here. (20 KB)

Our “Standard mortgage rates” graph shows the average floating, one-, two- and five-year fixed rates over a 14-year time period. Over that time, the average one-year rate was 6.4% while the average two-year was 6.6% . Average floating rates (7.04%) were cheaper than five-year rates (7.2%).

So you would’ve been slightly better off on one- and two-year fixed rates than floating or longer fixed rates.

If you want more flexibility to make repayments, you could put a portion of your loan on floating and the rest on fixed. This means you’ll be able to repay part of your loan more quickly if you’ve got the cash available but still have reasonable certainty about the size of your repayments.

Mary Holm, financial columnist and author of Rich Enough? A Laid-Back Guide for Every Kiwi, said “having at least part of your loan on floating means if you receive an inheritance, win a lottery or get redundancy pay, you can pay down your mortgage without penalty. And if you want to use an offset or revolving credit mortgage these are only offered as floating mortgages”.

She cautioned that, although rates are currently low, check you’ll be able to manage payments if interest rates rise. You can work this out by using our mortgage calculator. You can also ask your bank to show you how different repayment strategies will affect what you pay over the term of your loan.

Special rates

Last year, the Reserve Bank eased restrictions on new lending. From 1 January, up to 20% of new loans can be to consumers with deposits of less than 20%.

Mary Holm said if you’re scraping together a deposit, “you’ll be able to buy a home more quickly. But if you’re forced to sell when prices have fallen, you may end up owing more than the sale of your house”.

From the bank’s perspective the smaller your deposit, the riskier its investment. So the more you can stump up towards your deposit the better. Not only will you have greater equity, you may be able to bargain your way to a “special” interest rate.

These rates are lower than the standard fixed-rate of the same term (see our “Special mortgage rates” graph). In December 2018, the average one-year rate was 4.75%, an average special rate of 4.09%. Over 20 years, on a $300,000 mortgage you’d save more than $25,000 in interest on the lower rate.

Special mortgage rates

Download this table in PDF format here. (19 KB)

Mobile managers

Banks have their own mobile mortgage managers who specialise in home loan sales and can come directly to your home or work. But there have been concerns about how they get paid.

In November last year, the Financial Markets Authority (FMA) reported on the sweeteners banks use to motivate their salespeople. It found bank incentive schemes are highly sales focused, which increased the risk of inappropriate sales practices. The total variable pay (income additional to wages or salary) for the year ending 31 March 2018 for salespeople was $71 million across nine banks.

The report singled out mobile mortgage managers because their variable pay is primarily based on sales performance. Accelerators, where the commission percentage increases with the amount of lending, were also common.

We asked eight of the banks in the report (one doesn’t offer residential loans) how their incentive payments for mobile mortgage managers were calculated, and whether any review of incentives was being done.

Westpac said that in October last year it introduced a “balanced scorecard approach” for mobile managers where performance includes customer service, risk and compliance, lending and staff behaviour. It has also removed sales targets for branch and contact centre staff.

SBS Bank is reviewing sales schemes with a view to implementing one scheme for all staff, including mobile managers. From 1 April, its incentive scheme will not include sales.

Kiwibank calculates its incentives on lending, but to be eligible certain customer-focused behaviours must be met. Its review of incentives will include all staff, including mobile managers.

The Co-operative Bank said its purpose is to benefit its owners, who are also its customers and its remuneration framework reflects this.

ASB said it’s reviewing all incentives, including those for mobile managers. TSB is also reviewing the way it uses incentives. ANZ and BNZ didn’t respond to our inquiries.

By March, all banks must inform the FMA what changes they’re making to their incentive schemes or justify how they are going to manage the conflicts of interest they create.

Mortgage brokers

What about using a mortgage broker?

Getting a mortgage for the first time can be daunting – there’s lots of paperwork, loan decisions, and haggling to get the best rates. Mortgage brokers promise to do the legwork for you. In our 2017 survey of consumers who had used a mortgage broker, 54% were first-home purchasers.

A mortgage broker is essentially a middle-man between you and the bank. A broker should assess your financial situation, help you decide how to structure your loan, and present you with loan options. Brokers typically work through a dealer group (also known as an aggregator). These groups negotiate commission arrangements between the broker and the lenders.

Mary Holm said a good mortgage broker will know about the options offered by different lenders. “They can also be helpful for people who might find it difficult to get a mortgage because of their age or credit record,” she said.

However, brokers don’t work with all lenders so the deal they can get for you may not be the best in the market. As Ms Holm points out, if you decide to use a broker it’s important to ask which lenders they don’t represent and check out their offers yourself.

You should also ask what they stand to get paid from recommending a particular lender. You don’t pay a broker – they’re paid commission by the lender. What they’re paid could influence the lender they recommend.

If you decide to use a broker, it’s important to ask which lenders they don’t represent and check out their offers yourself.

Brokers don’t have to disclose their commission and many don’t. In our 2017 survey, 62% of respondents said the broker didn’t disclose how much they’d get from arranging the mortgage recommended.

The New Zealand Brokers Association, a voluntary industry group that represents about 950 brokers, said its members must tell you how they are being paid and the nature of the payment, but doesn’t make them disclose how much.

Changes are in the pipeline to beef up brokers’ obligations. As things stand, a mortgage broker doesn’t need any qualifications. However, they must belong to a dispute resolution scheme. If you’ve got a complaint about a broker, you can take the case to the scheme. The FMA also monitors complaints about brokers.

Mortgage tips

Consumer’s tips for saving on your mortgage:

  • Borrow as little as possible: if you want to borrow an extra $50,000 for renovations think about the extra cost. If you borrow $300,000 instead of $250,000 at 5% over 20 years, you’ll pay an extra $29,000 in interest.

  • Negotiate: don’t assume the advertised rate is what you have to pay. Ask banks to match other offers. You can also haggle on things such as interest rates and fees on other accounts.

  • Time is money: get as short a term as you can afford – the payments will be higher but you’ll pay much less in interest. Shaving five years off a 20-year mortgage of a $300,000 loan at 5% will reduce the interest you pay from $175,000 to $127,000 – a saving of about $50,000! Another tip is to pay half your monthly repayment fortnightly. As we all know, broadly speaking a month is two fortnights. But there aren’t 24 fortnights a year; there are 26. Paying half your monthly repayment every fortnight means, in effect, you will make an extra month’s repayment each year. You probably won’t even notice.

  • Make regular payments as large as possible: do a budget and work out how much you can pay off your mortgage. Even a little bit extra over 20 years can make a big difference.

  • Make extra payments: whether it’s drip-feeding small amounts or making a one-off lump sum. Before you do, check for extra fees you might incur on a fixed-rate.

  • Don’t be swayed by extras: lenders often entice you with loyalty schemes such as FlyBuys and Airpoints. But these don’t stack up financially compared with a lower rate and shorter mortgage life.

  • Don’t be afraid to swap banks: it may be a hassle but a good way to get the best deal. Your new provider will help you make all the changes.

  • Don't pay off the mortgage before you pay off higher interest debt such as credit cards, credit sales (formerly known as HP), and car loans.

  • Don't add a car to your mortgage, then pay it off over 25 years. Chances are it'll be in a wrecker's yard before you've paid it off. If you do this, make sure you pay it off in the same period of time as you would have done for a car loan. Otherwise, you'll have paid much more in interest than if you'd taken out a regular car loan over 5 years from a reputable lender.

  • Remember to allow for worst-case scenarios – for example, take out insurance cover in case you become redundant. Don't take action too late. The Credit Contracts and Consumer Finance Act allows you to ask the lender to spread your payments over a longer period, or to change the terms of your credit contract, if you can prove hardship (see "Mortgagee sales", below). But you can only do this if you're not already behind in your payments.

  • Watch out for mortgage-reduction agencies. They operate by refinancing your existing mortgage using a revolving-credit facility, and charge quite high fees for the privilege. If you want revolving credit, forget the separate agency and go straight to your bank. They'll set it up for a fraction of the cost. You should also be cautious of deals offered by people who reckon they can lend you money with no deposit. Some of these are legitimate offers, but others are scams. Get your lawyer to check the paperwork before you sign anything.

Mortgage types 101

Table mortgage: repayments don’t change over the life of the mortgage except when interest rates change. At the beginning, most of each repayment is interest, by the end you’re mostly paying principal (the amount you borrowed). You’ll have the discipline of regular payments and a set date when your mortgage will be paid off. You can take a table loan with a fixed or floating rate.

Reducing mortgage: on each repayment, you pay the same amount of principal. This reduces the interest each time so each payment is less than the previous one but payments start high. This may suit borrowers who expect income to drop, for example one partner giving up work in a few years’ time.

Interest-only mortgage: you only pay the interest portion so the principal doesn’t reduce. But you’ll have to start paying the mortgage sometime. It can be a risky option if property prices drop and you have to sell.

Revolving credit facility: this works like a large overdraft. Interest applies whenever the account is overdrawn and the account can be overdrawn at any time up to the maximum of the mortgage. Revolving credit is flexible but you need to be disciplined at reducing the overdraft and avoid the temptation to never quite pay down the balance. A revolving credit facility is only available with a floating rate.

Offset mortgage: uses your savings to reduce the interest you pay and the length of your mortgage. Your savings and loan accounts are linked. Your savings are subtracted from your mortgage and interest is charged only on the balance. Some banks let you and your family link several accounts to cut down your total debt. Offset mortgages are only available with a floating rate.

Interest rate options

There are 2 main types of interest-rate (and 2 hybrids).

Floating: The lender can change the interest rate on the mortgage whenever they choose. A floating-rate mortgage offers you wide scope to change your plans too. You can make extra repayments, increase or decrease repayments (subject to some limits), or repay the mortgage early, without copping penalty fees.

Fixed: The lender cannot change the interest rate for a certain period, such as a year. This gives you certainty, and floating rates are usually higher than fixed rates prevailing at the same time. This explains why fixed-rate mortgages are very popular these days. But with a fixed-rate mortgage you will often face a penalty if you want to change the conditions.

Capped rate: A compromise is a capped rate. If floating rates rise above the cap, the cap doesn't follow, but if floating rates drop below the cap, the capped rate drops too.

Discounted rate: Another alternative to a fixed-rate deal is to have a discounted rate. This guarantees you stay below the floating rate – whichever way it moves – for the length of the discount, provided you have all of your loan in it.

Mortgagee sales

If you can't repay your mortgage, as a last resort the lender has the right to sell the house to get its money. Most lenders will want to help you find other ways to meet your obligations before selling the property.

If you're struggling with your finances, the best thing to do is contact your lender before you get behind on your payments. If you're not already behind in your payments you're entitled to ask the lender for a change to the terms of your contract to help you meet your obligations. This could be getting a mortgage holiday or decreasing the amount of your repayments while increasing the length of your loan.

If you're already behind on your repayments contact the lender and be upfront and honest. Ask if it is prepared to come to an arrangement to help you meet your obligations. Do your best to meet ongoing payments, return phone calls and keep a record of who you talk to and when.

Letter of demand: This is the first formal step in the debt recovery process. It advises you of the amount you owe in arrears and demands payment by a certain date.

  • Try to pay the arrears and your ongoing loan repayments.
  • Talk to the lender. If it's not prepared to enter into a repayment programme, you may want to consult a lawyer for advice about your options.

Property Law Act (PLA) notice: If you don't pay the arrears advised in the letter of demand, the lender may issue a PLA notice. This states you are in default under your mortgage because you have failed to pay the amount in the letter of demand. The PLA notice tells you the amount you need to pay by a certain date (a minimum of 20 working days after the PLA notice is issued).

  • Contact your lender if you haven't already done so, and ask whether you can enter into a repayment programme.
  • Consult a lawyer for advice.

If you don't pay the full amount owed in the PLA notice, including costs, the lender has the right to sell your property.

Making a complaint

If you have a problem with your bank, there are 3 main steps you should take:

  • Ask to speak to the branch manager about your problem.

  • If they can't sort it out, ask to go through the bank's formal complaints process.

  • If that still leaves you dissatisfied, contact the Banking Ombudsman.

Repayment calculator

Enter your loan details to calculate your regular repayments and the total interest you'll pay over the term of the loan. (The calculations are for a standard table mortgage.)

Rent or buy?

Use our calculator to compare the financial implications of buying and renting over 20 years.

  • The calculations are based on the assumption that, if you rent, you invest the money you would otherwise have spent on house buying - the deposit, insurance, ongoing mortgage payments (minus rent) etc.
  • While we've made every effort to keep the assumptions underlying our model reasonable, it's still just informed guesswork. You can play around with the figures to see what impact changing them has.
    Note: Real interest rate = the interest rate on your savings, after tax, less the inflation rate.

Should you rent or buy?

As well as potential increases in the real value of your house, home ownership has other benefits. You can use your house as security to borrow more money. There's also the pride of owning your place, which you can alter as you please, knowing that no landlord can evict you. Moreover, repaying the home loan can be viewed as a form of compulsory saving.

But there are disadvantages with home ownership. It costs a great deal of money to buy and run a house. You'll need a deposit, and have to find money for mortgage repayments, insurance, maintenance, rates, etc. If you're renting, you could invest that money (less your rent). Also, if you want to move, there's the hassle and cost of selling your house. If you live in a flat, you can just give notice and leave.

Having all your money invested in your home is common in New Zealand, but does run the risk of lack of investment diversity - if house prices in your area fall, you will have lost money.

Jargon buster

Establishment fee

Also called the "application fee", this is the fee to set up the mortgage. The establishment fee may be set at a minimum or maximum dollar amount, or some percentage of the amount borrowed. It is often negotiable.

Lending limit

The maximum percentage of the house valuation the lender is generally prepared to lend up to. In some circumstances, lenders may lend a higher percentage but could charge extra for this.

Mortgage

Strictly speaking, this is a legal document that secures property for a loan. But, like most people, we also use the term to mean a loan to buy a house. The "mortgagee" is the lender and the "mortgagor" is you, the borrower.

Mortgagee sale

If you cannot repay the mortgage, as a last resort the lender sells the house to get its money.

Principal

The amount you borrow.

Reducing mortgage

Each repayment comprises the same amount of principal. That means the interest charge is less each time, so each repayment is less than the previous one (assuming interest rates don't change).

Revolving-credit facility

Essentially a large overdraft secured by your house, which you access using a cheque account or credit card. The interest rates on revolving-credit facilities are usually around the same as normal floating rates.

Table mortgage

The most common form of mortgage. Unless interest rates change, the repayments do not alter over the life of the mortgage. But the interest and principal components of each repayment do change. At first, most of each repayment is interest - by the end, most is principal.

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