What is a Fixed Interest Rate?
A fixed interest rate is when your home loan doesn't fluctuate during the fixed rate period you have chosen. This allows you to accurately predict and budget for future mortgage payments during the fixed rate period.
Fixed rates works well for families who want their mortgage payments to be the same each month for a set period of time. The period of time that you fix your rate in most cases is determined by how long you intend to live in your property and if you believe that interest rates are going to increase in the short to medium term.
Long term rates are not always the 'best' rate as interest rates tend to be cyclical - this is what happened in March 2007 to July 2008 when interest rates increased sharply and there was a mad rush to fix rates. Many people fixed their rates for 4 to 5 years because it was the cheapest rate at the time - but not necessarily the best rate for their circumstances.
Unfortunately (for many) in July 2008 rates started dropping and by January 2009 the OCR was 3.50%. The cost to break these long term fixed rates numbered in the thousands of dollars and in some cases tens of thousands of dollars.
Bear in mind since
2004 historically the yield weighted average interest rate for:
Floating is 9.55%pa - 1 year is 8.74%pa - 2 years is 8.92%pa - 3 years is 8.39%pa -
4 years is 8.91%pa - 5 years is 9.05%pa
fixing, how long for?
The pros and cons downs of different fixed rate terms.
rates now: Right now, short-term rates are lower and floating
rates are the lowest of all. Sticking with these will mean you’ll
less for your loan in the short-term.
• May stay low: If the RBNZ lifts rates more gradually than expected, floating would continue to be the cheapest option.
• Flexibility: If you have a floating rate, you can always lock in a fixed rate at any time. You can also make extra repayments if you choose.
|• Missing a deal: Getting
a 1-year term may give you fewer benefits
than a 2-year term if rates go up as expected – especially if the RBNZ lifts interest rates more aggressively than currently expected.
|• More certainty: By fixing now, you’ll
know how much your
payments will be, regardless of any changes.
• 3-year rate is unlikely to stay as low as it is now. This could be a good time to take advantage if you like to know what your repayments will be for three years.
|• Chance of paying extra: If the RBNZ increases the OCR more gradually than expected you may end up paying interest at a higher rate for longer than you need to.|
|• Certainty: With these rates you’ll know exactly what your repayments will be for much longer than shorter terms.||• Higher rates: If the OCR goes up more gradually than expected you could end up paying more than you need to. If rates drop and you want to change your term, you may be charged break fees.|
Should I break my fixed rate to get a better rate?
The cost of breaking your mortgage fixed rate can differ depending on the following variables. What your current interest is, the term you are fixed for, the loan amount, the term remaining, the current interest rate either wholesale or retail.
The penalty fee is complicated but roughly equates to $1,000 per $100,000 borrowed for every 1% fall in rates, and for every year of its remaining fixed-rate term. Generally, you won’t financially benefit from breaking fixed rates and refinancing when interest rates are falling. The early prepayment fee will offset any benefit in interest payments saved unless you have the cash to pay the penalty, in that case there are some reasonable savings to be made. If you have the cash then it may be better just to pay off this amount off the principal - So let's look at the numbers..
For example; a $400,000 home loan over 30 years at 9.00%pa fixed for 5 years with 3 years to go. Repayments are $3,218 per month.
So if interest rates fall by 3% and you want to break your fixed rate your $400,000 loan will face a penalty fee of around $31,912.
For most people they don't have the cash to pay the penalty break fee upfront - they need to add it to the loan. With a break fee of $31,912 added to your exisiting loan. $31,912 @ 6.00%pa is and extra $191 per month - But over the next 30 years you will pay the bank back $36,966 in interest. Now your break fee has cost you $68,878.
your new repayments be?
$400,000 @ 6.00%pa over 30 years $2,398 per month - a difference of $820 per month. That's a pretty good saving. With the break fee added $431,912 - $2,589 per month - a difference of $629 per month. Not bad.
Based on these figures however it will take over 7 years to break even. Not so good.
Before you break
a fixed rate you need to know your numbers - call us and we can help you
make that decision easier based on facts not fiction.
Call us on 0800 ADVOCO (0800 238 626) or email us.