When interest rates start to fall, our phones start ringing. One of the (understandably) most common requests is to secure a cheaper interest rate.
In some countries, it’s an easy exercise to get out of your high fixed rate and onto a cheaper rate. In the US for example, homeowners can fix their mortgage for 30 years and if they want to ever get out of that rate they know on day one what it would cost to get out.
Unfortunately in NZ it’s not that simple. The longest fixed rate we’ve had in NZ in recent times has been 10 years (those who chose that regretted it as rates soon after plummeted), with the most popular rate historically being 2 years fixed.
We have a nasty thing in NZ called ‘fixed rate break fees’. When you take a fixed rate with a lender here, take a 2 year fixed rate for example, it’s a contract you’re making with the bank, and if you want to get out of that rate before it expires you’re liable to pay a ‘fixed rate break fee’.
Unlike some other countries, in NZ we don’t know what that break fee might be until the day you break your rate. And it changes daily. The reason for this is that banks borrow money both domestically and internationally to fund your mortgage. They pay the going rate to who they’ve borrowed from, put a margin on top, and lend it to you for your fixed rate mortgage.
Let’s say the bank borrows from an American bank at 2.49%, then slaps a 2.5% margin on top and lends to you fixed for 2 years at 4.99%. You then decide to repay the loan after 1 year. If the rates have gone down to 4.00% at that point, the bank can only on-lend at the lower rate meaning they lose. Banks don’t like to lose, so they charge you the break fee which covers their loss.
The general rule of thumb is that if rates have gone down there will be a break fee. If rates have risen since you fixed, there may not be a break fee. But it really is impossible to forecast in NZ what fixed rate break fees might be with any certainty. Which is why a lot of Kiwis don’t like to fix for too long.
Something we do a lot of is break evens for those who are wanting to break out of fixed rates. This shows in dollar terms the cost and benefit of breaking and refixing so homeowners can make informed decisions, minimising the guess work. We’ll look at that in the next column.
*Not financial advice, contact us for tailored advice.
