Should you fix or float, or both?
There's an old joke that goes something like this: why do economists exist? To make weather forecasters look good.
Without wanting to be too harsh on economists, predicting where interest rates are going to be at any future point is a very difficult task.
They certainly don't get it right all the time, so how can someone taking, or renegotiating, a mortgage be expected to?
Seeing into the future is not a service your bank offers but there is some guidance on which type of mortgage might best suit your needs.
"Your bank can help you understand your options, and structure the right mortgage for you," says Vince Clark, ASB head of home lending and term deposits.
What are the options?
Floating: Also called variable rates, these can often be lower than some fixed rates which is appealing to some borrowers. They also offer the flexibility to make extra and lump sum payments whenever it suits you.
On the flipside, on a floating rate you are exposed to interest rate rises if the Reserve Bank decides to increase the Official Cash Rate (the rate the Reserve Bank pays or charges banks on the settlement accounts they hold with the central bank).
While floating rates aren't priced off the Official Cash Rate, they are a big influencer of how banks set their rates. So if you are risk averse and/or on a tight budget, this may not be the one for you. Property investors often tend to favour floating rates for the flexibility they offer.
Fixed: This is when the interest rate you pay is locked in for a set period of time (from six months to five years). Overseas, mortgages can be set for up to 30 years but the New Zealand financial system is not set up for that at the moment.
The benefits of fixed loans are that you know how much you will be paying in each instalment and you are protected from interest rate increases during the term of the fixed rate.
The downside is that they are less flexible when it comes to making one-off or extra payments. You may also be charged a break fee if you change or end your mortgage.
First home owners often favour a fixed rate for the certainty it offers as they get used to life with a mortgage.
What's right for you?
Your personal circumstances are another thing to consider when deciding whether to fix or float. For example, if you are likely to want to sell your property in the short term, then a long term fixed rate won't be a good idea.
The trick when choosing how long to fix for is to predict where interest rates will be when your mortgage expires. Ideally, you want the rates to be lower at that point.
In the stable interest rate environment New Zealand has experienced over recent years, floating rates have been the most popular. But the 'flight to fixed', as banks call it, is increasing.
"Fixing your mortgage is tempting in times of rising interest rates, but there are other options," Clark says.
Splitting your mortgage between fixed and floating is one option. This gives you stability for a chunk of the debt, in knowing how much you are paying back each instalment and some protection from interest rate increases. It also offers the flexibility to make some extra payments.
"The temptation will be that with interest rates now increasing, customers will put everything onto a fixed rate. While that's understandable, it's worth taking a moment to think about the pros and cons of fixed and floating interest rates. If in doubt, talk to your bank," Clark says.
- If you need flexibility, opt for floating.
- If you prefer to know what your regular payments will be, sign up for fixed.
- Want the best of both worlds? Consider a split option.
Click here to find out more about getting a home loan with ASB.