Mortgages: To fix or not to fix, that is the question

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First-time buyers are being warned against rushing into borrowing a large amount based on low rates.

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THE LATEST round of interest-rate changes have widened the gap between short and long-term fixed rates, leaving homeowners pondering their mortgage options.

The experts say choosing how long to fix a mortgage or whether to fix it at all depends on how much risk you want to take, the degree of certainty you want in knowing what payments will be, and how much you can afford. But they say actively managing your mortgage, and choosing the best rates for your situation, can potentially shave thousands off interest costs.

Broker John Bolton from Squirrel Mortgages believes it's now best to split a mortgage into pieces, fixing chunks for a range of terms at the varying interest rates.

Bolton calculates that using a series of short fixed-term rates could be the best value. For example, a homeowner with a $400,000 mortgage could save up to $32,000 in interest over five years by using a series of one-year rates rather than fixing at a five-year term which is almost 3% higher.

The calculation is based on Bolton's belief that although interest rates will rise, they will not do so quickly. Even using a more conservative model where rates rose quickly, he thinks mortgage holders could still save thousands.

"The way the rates are at the moment, they would have to go up incredibly fast for the long-term rates to make sense."

Last week, one-year fixed rates at most banks were around 5.5%, two-year fixed rates around 6.5% and five-year fixed terms hitting close to 8.3%. Floating rates, which mean the borrower pays more or less as rates go up or down but aren't locked into one rate, recently hit a 40-year low, with most banks charging around 6.45%.

Bolton said many people chose to fix at long-term rates to provide certainty, but points out that even doing so doesn't mean completely escaping potential interest rate rises.

"You've brought yourself three years of sleeping at night knowing that your rates won't go up, but in three years' time you're going to get a massive jump. The reality is even with a fixed rate you can't avoid higher interest rates you can only avoid how quickly that will happen to you."

One way to avoid this was, he said, always to budget to pay around 8% and when interest rates were lower simply pay off your loan faster.

Financial commentator Bernard Hickey from interest.co.nz points out that the average two-year fixed rate in New Zealand since 2002 had hovered around 8%, making that a good figure on which to base future affordability equations.

He said everyone's needs were different, but the current floating rates could suit people who had paid the bulk of their mortgage, and the short-term fixed rates over six months, one year and two years were the cheapest.

Hickey cautioned first-time buyers against rushing into a decision based on low rates, which could rise, and at a time when job losses were possible and significant pay rises unlikely.

"If I was talking to my brother-in-law I'd say that you have to realise you're taking on some big risks if you borrow to the hilt at 5.5% ... You could be stuck in two years' time with an interest rate of 8%. Can you afford it considering your wages are not going to change?"

One of the issues about making mortgage decisions is that many New Zealanders don't understand how they work. A recent survey by ANZ and the Retirement Commission revealed 37% of people did not understand whether it was better to have a fixed-rate home loan when interest rates were rising or falling, and one in five thought the interest rate on a "fixed-rate" loan could change during the term of the loan. It can't.

Retirement Commissioner Diana Crossan said the best thing people could do was educate themselves using websites such as sorted.co.nz to familiarise themselves with financial terms, and so they knew what questions to ask their bank or broker.

For more information on Bolton's calculations check out his blog on: www.squirrel.co.nz

For general information about mortgages check out: www.sorted.co.nz