Mortgages: Should you fix or float?

In November last year, Kiwis owed about $300 billion on their mortgages. Approximately 86% was in fixed-rate mortgages (where the interest rate is set for a specific period), with the other 14% on a floating rate (where the interest rate can go up or down at any time).

More than 70% 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 know exactly what your payments will be. This makes budgeting easier and you won’t be affected if rates rise.

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 you’ll miss out if interest rates drop.

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 budgeting more difficult, 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 David Tripe, Professor of Banking at Massey University school of economics and finance.

“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 13 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 to November 2020 and the average floating rate was 4.51% (a more manageable $13,530 a year in interest on a $300,000 loan) and the one-year rate had dropped to 3.34%.

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

Standard mortgage rates

Our “Standard mortgage rates” graph shows the average floating, one-, two- and five-year fixed rates over a 16-year time period. Over that time, the average one-year rate was 6.12% while the average two-year was 6.29%. Average floating rates (6.83%) were cheaper than five-year rates (6.89%).

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

If you can stump up more towards your deposit it’s 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 November 2020, the average one-year rate was 3.34%, compared with an average special rate of 2.53%. Over 20 years, on a $300,000 mortgage you’d save more than $29,000 in interest on the lower rate.

Special mortgage rates

Mobile managers

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

In November 2018, the Financial Markets Authority (FMA) reported on the sweeteners banks use to motivate their salespeople. It found bank incentive schemes were 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.

Banks were required to advise the FMA what changes they would make to their incentive schemes or justify how they were going to manage the potential conflicts of interest. As a result, all banks committed to removing sales incentives for frontline staff and their managers.

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 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.

All mortgage brokers must comply with financial advice regulations. They must have a complaints process in place and 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.

Mortgage tips

Our 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.

• 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. However, if you’re on a fixed rate make sure to check you won’t incur any fees when doing so.

• 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.

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

• Avoid adding extras to your mortgage: For example, getting a car then paying 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.

• If you're having trouble making payments, talk to your lender: For example, take out insurance cover in case you become redundant. 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").

• 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 small 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 signing 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 it chooses. 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, 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 emails 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.