Mortgage rates as cheap as chips at under 4% – to fix, or not to fix?

Last week we looked at how changes in headline interest rates in New Zealand versus other countries can affect your overseas travel plans. But, such changes in interest rates will impact on your other personal finances as well, such as the effect it has on any unpaid loans you may have outstanding.

The loan you have on your property ties you into an obligation to make regular repayments to your bank, or the business lending you the money, over a number of years. The loan is awarded to you based on mortgaging the property to the bank – this is to cover the bank for the risk that you may not make good on your repayments.

The cost to you for borrowing that money is determined by how long you have taken the loan out for – meaning, the period of years by the end of which you commit to repay the lender the entire loan amount. Home loan mortgage rates in New Zealand currently range anywhere from 4.39% to 4.85% if you decide to fix the rate for the next 3 years, depending on which provider you choose. On the other hand, if you decide to not to fix your mortgage rate (variable), providers offer rates anywhere between 5.75% and  5.95%.

So how do you decide whether to fix your mortgage rate, or not?

If you lock in the cheapest variable mortgage rate today on a $500,000 loan, the cost to you will be 5.75% – approximately, costing you $86,250 over the next three years (on an interest only loan). This is assuming there will be no changes to rates in that period.

On the other hand, if you locked in the cheapest 3 year mortgage rate, your cost will be only $65,850 over the same time. That’s a saving of $20,400 in 3 years.

Should mortgage rate rise over the next 3 years, it may be better to fix it at a lower rate today. Instead if mortgage rates were to fall over the next 3 years then it may be better not to fix it. But given that variable rates are at a margin above the fixed 3 year rate, variable rates will have to fall by about 1.25% on average before they become as compelling as the fixed rate.

Longer term mortgage rates are determined by banks, typically based on the rate at which they can borrow from international banks. While there is no guarantee, you should expect long term mortgage rates in New Zealand will trend along with changes in interest rates overseas. Shorter term rates on the other hand are driven by a range of reasons including competition between banks as well as the level of the overnight cash rate (or the short term borrowing cost, set by the Reserve Bank of New Zealand).

Borrowing costs in the US have been trending steadily up over the last 18 months and is largely expected to trend upwards (assuming no major economic issues). On the other hand, short term borrowing rates in New Zealand are largely on hold and may even see the possibility of a cut.

If you are none the wiser about which way rates may trend, your decision to fix or not should be determined by your sense of comfort. Locking in a rate today ensures you know exactly how much you would be paying over the period you have chosen.

If you didn’t want to be exposed either way for too long, you could always choose a shorter period like 18 months. The cheapest 18 month mortgage rate now is 3.99%.

The Pocketwise Team

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