You can choose between fixed or floating interest rate types when you take out a mortgage to buy a home or investment property.
A fixed interest rate mortgage allows you to lock in a specific interest rate for a particular period (usually between 1 and 5 years). During the specified period, your rate does not rise, but it won’t fall either. However, a floating-rate loan can change at any time.
Fast facts: fixed rates
- Interest rate. A fixed interest rate is typically lower than a floating rate.
- Flexibility. A fixed-rate mortgage is less flexible because you are “locked-in” to the loan for the period you sign up for. A fixed-rate loan is a contract. For example, you usually can’t make extra repayments once you lock in the rate, and there may be higher costs for leaving the mortgage to refinance. So always read the fine print. Once the fixed-rate period ends, you go onto a floating rate, which is a perfect time to look around and see if you can refinance to a better deal somewhere else.
- Extra repayments. You might not be able to make extra repayments on your mortgage, meaning you can’t make headway on your loan principal by paying more than the scheduled repayment each month.
- Break costs. If you want to sell the property or refinance to another mortgage whilst you’re still in a fixed loan contract, the break fee the lender charges for leaving the loan can be substantial – sometimes thousands of dollars.
- Features. If you have some savings behind you and you’re looking for loan features like an offset account with your mortgage, then a fixed-rate loan may not be suitable. Fixed-rate mortgages with offset accounts are comparatively rare.
Let’s weigh the positives and negatives of fixed rates in more detail.
- Repayment certainty. A fixed-rate mortgage offers you peace of mind knowing your repayments, which allows you to budget more effectively.
- Security. You are protected from interest rate rises with a fixed-rate mortgage as you lock in your interest rate for the specified term. If rates increase, you come out ahead.
- Flexible loan terms. Fixed-rate mortgages are available from many New Zealand lenders with a variety of fixed loan terms available.
- Low rate offers. Many lenders offer competitive fixed rates with cashback offers.
If variable interest rates rise during the fixed-rate period, on a fixed rate, you might end up with a better rate than the average. If they go lower, you may end paying a little more, but for some, this is a risk worth taking for the peace of mind of knowing their mortgage is affordable and repayments won’t change.
- Limited features. Fixed-rate loans don’t have a lot of flexibility compared to floating rate mortgages. Most lenders don’t offer fixed home loans with 100% offset accounts, which means if you have any savings, you can’t offset them against the interest you’re paying on your mortgage.
- Break costs. If you decide to break out of a fixed-rate mortgage before the end of the specified term, you may face a break cost. Refinancing, a new job, moving overseas, getting divorced: none of these reasons gives you a “get out of jail free card” with your lender. You must compensate the lender based on how much they stand to lose on your loan. They may stand to lose nothing (unfortunately, this doesn’t mean you get a payout!) However, if they stand to lose money, they charge you accordingly, which can cost a few hundred or potentially thousands of dollars.
- Rates could drop. If the Reserve Bank of New Zealand slashes the official cash rate (OCR), you could have a higher rate than floating home loans.
When your mortgage’s fixed period ends, your loan automatically switches to a floating loan with the same lender, and you pay the rate that the lender charges at the time.
There’s no possible way to know the floating rate one to five years into the future. Still, when you sign up for the loan, your bank informs you of their current revert rate, which is the floating interest rate that your fixed mortgage switches to after the specified time if interest rates remain the same over that period.
The floating rate you end up paying may be higher or lower.
Importantly, once your fixed rate ends, you are free to refinance your mortgage – at which point, you can choose whether to refinance to a lower floating rate or sign up for another fixed-rate period.
What happens if I want to end my fixed rate home loan early?
It may be possible to end your fixed-rate mortgage contract early, but there could be a hefty price to pay.
A fixed-rate mortgage is a legal contract between you and your lender, which guarantees that you’ll repay a fixed amount of interest on a loan over a specified period.
Suppose you decide to break that contract by switching mortgage or lenders or selling the property and closing the mortgage altogether. In that case, your existing lender wants to be compensated for any loss they incur. Breaking a mortgage during a fixed interest period can be expensive.
Do fixed-rate mortgages let you make additional repayments?
Some fixed-rate home mortgages let borrowers make additional repayments and can usually be made up to a limit set by your lender.
In most cases, if you make additional repayments above the set limit or repay the fixed-rate mortgage in full, you may incur additional break costs for “early repayment”. Check the outline of fees with your lender before you start to make extra repayments.
To find a good fixed rate product that may suit your needs, consider the following five essential questions.
- How long do I plan to live here? Not sure whether you want to stay in your home long-term? Considering moving in the next 12-24 months? Or are you not sure what the future holds and don’t want to be locked in? If there is any chance you may wish to sell the property during the fixed-rate period, then think twice before signing up for the mortgage. Break costs can be expensive.
- What are the interest rates on offer? Of course, for any mortgage interest rate, a lower rate is going to save you money. However, as mentioned above, that’s not the only consideration. If there’s a chance you may need to sell the property, or you’re not sure of your plan in the next few years, it might be worth looking at floating rates to see if a competitive rate is on offer.
- Are there any other fees I need to know about? Another consideration is the fees your lender charges. Always pay attention to a loan’s costs, especially annual or ongoing fees. These can quickly add up and cancel out the benefits of the lower interest rate.
- What fixed-rate period should I lock-in? Fixed-rate borrowers have to choose between one to five-year fixed rates. Most mortgages give you multiple options, with different rates for each. Shorter fixed periods are typically lower, so one-year fixed rates are more competitive than five-year fixed rates.
- What are my short-term property goals? If you want to make extra repayments into your mortgage to chip away at the loan principal as quickly as possible, then a fixed-rate loan may not be the best option, as extra repayments are often not allowed on these types of loans.
Can fixing be cheaper even after paying break costs?
Breaking a fixed-rate mortgage to refinance to a lower rate can be expensive. However, if your repayments get significantly lower after ending your fixed-rate mortgage, you could still end up saving money in the long run.
Let’s look at a quick example. Say you have a 3-year fixed-rate mortgage with one year left on the fixed period.
You fixed your rate at 3.90%, and you have $400,000 remaining on your loan. The mortgage term is 30 years. Because fixed rates are lower now, your lender is offering a fixed rate of 2.40% for new borrowers.
You can use this lower rate to get a rough estimate of your loan break costs. The difference in your original fixed rate versus a current offer of 3.00% can stand-in for the more complicated difference in funding costs. The basic break fee calculation is:
- Loan amount ($400,000) x fixed period remaining (1 year) x rate difference % (0.60%) = $2,400
Bear in mind that this is an estimate only, and every lender has its way of calculating break costs. Several things are factored in, including
- The length of the fixed-rate term remaining
- The value of the mortgage
- The lender’s current fixed-rate offer
- The current Bank Bill Rate (BBR)
Assuming that your break cost is $2,400, as per our example above. Now, consider the potential savings if you switch to a much lower rate from another lender, such as 2.19%. You save money in the long run, even when paying the $2,400 break fee, because your repayments are lower.
|Saving minus break cost||N/A||$2,040|
In the first year after switching, you save around $2,000 even after paying the break cost.
After the first 12 months, you save even more over the life of the mortgage if the 2.19% interest rate is lower than the floating rate on offer at the time.
A split-rate mortgage could be the ideal solution if you’re not quite sure whether you should go for a fixed or a floating rate loan.
Some lenders allow you to split your mortgages into fixed and floating portions, which essentially lets you hedge your bets.
For example, you could choose to lock in 70% of your mortgage to a fixed rate. The benefit of this is the lower interest rate and repayment certainty. You then attach the remaining 30% to a floating rate mortgage. The advantage is that you can still access features like an offset account to pay less interest based on your savings. Also, if you ever have to end your loan for any reason, the break cost is lower as only 70% of the loan’s value is fixed.
A split mortgage may be the best of both worlds. If you’re still not quite sure which option is best for you, consider speaking to a mortgage broker for expert advice.
In short, if you value certainty over flexibility, then a fixed rate could be for you. On the other hand, if you care about extra repayments and mortgage features, you might be better off with a floating rate.
Use our switching costs calculator to help you calculate whether refinancing your loan now ends up saving or costing you money.