I want to break free (and refix my rate)

Wow, A lot can happen in a year! Cast your mind back to mid-late 2020, when New Zealand had just come off a period of lockdown. We couldn’t go out and spend money and subsequently, there was a pent-up demand to do so when we emerged from lockdown.

• Property markets surged after the initial lockdowns as buyers looked to enter the market, while others looked to upgrade after having ample time to consider their current living arrangements.
• Consumer spending increased on domestic travel, new cars, and renovations.
• Supply chain issues were amplified as businesses struggled to import consumer goods into NZ.

The Reserve Bank of New Zealand was stimulating the economy by:

• Reducing the Official Cash Rate (OCR) to a record low 0.25%
• Introducing a monetary easing program of buying back bonds to free up cash for spending
• Easing of Loan to Value Ratios (LVRs)
• Funding for lending program – where the banks could borrow directly from the RBNZ at the OCR
• Floating the possibility of negative interest rates from early 2021

This resulted in mortgage interest rates being driven to very low levels, such that in early 2021, all interest rates were under 3%pa (from one to five-year terms).

A year ago, it was popular to fix the loan for 12 months on the back of falling interest rates, with the view of picking up lower rates in a year’s time - particularly with the strong indications that we might head into a negative OCR.

Fast forward to mid-2021, and the one-year rate bottomed out at 2.19%pa and the five-year at 2.99%pa. The property markets were still rising quickly, with the government and RBNZ looking at ways to soften house price inflation and increase the supply of new housing being built.

Government/RBNZ introduced some changes to:

• They removed interest deductibility on existing rental properties (new builds exempt).
• Increased the bright-line test period from five years to ten when selling a rental property (new builds remain at five years).
• Reintroduced LVRs’s where an investor required 40% deposit/equity to buy a rental (new builds exempt).
• Reduced banks’ ability to lend to buyers with less than 20% deposit by half.
• Consult on the implementation of Debt-to-Income Ratio (DTI) to borrowers.
• Credit Contracts and Consumer Finance Act (CCCFA) changes required greater lender responsibility to ensure they better understood their clients' spending habits, and that the buyers are making informed decisions on the lending.
• Increasing the OCR from its low of 0.25%.

This year, inflation has risen initially in the June quarter to 3.3%pa and then in the September quarter to 4.9%pa. This is now outside the RBNZ threshold for inflation (1-3%), and the highest rate since the June 2011 quarter.

Additionally, unemployment (4.1% in June) has dropped to lows last seen in June 2008!

The RBNZ was likely to increase the OCR in August 2021, but NZ went into a second nationwide lockdown, and the decision was deferred to October 6th.

RBNZ Governor, Adrian Orr, mentioned in August that he sees the OCR moving to around 2% over the next 12 months or so, and he thought this would equate to the two-year mortgage interest rate of around 5%pa. This is on the basis that the banks would look to recover their full margins on lending.

The bank economists hold the view that interest rates are rising on the back of the OCR increases. Some lenders have moved to increasing their interest rates prior to the OCR change, so it is no longer a matter of waiting to see if there is a change in the OCR that might make a lender increase their rates.

The OCR was increased to 0.5% in early October, with more rises predicted over the coming 12 months or so. In November, the OCR was increased again by 0.25% to 0.75%. RBNZ comments was that the forecast is for the OCR to rise to 2.6% by the end of 2023 (this is up from the August forecast of a peak of 2.1%).

What should you do if you have a fixed loan at a cheaper rate than those on offer now?

Most home loans written in NZ in the last year or so have been fixed for one year, as clients chased the lower interest rates on offer. That means there are a lot of loans coming off relatively cheap interest rates in the next 6-8 months, that will be refixing at higher interest rates, possibly up to 2% higher. More recently, as interest rates have started to rise, the trend has been to fix for longer periods - around 3 years.

There is the option to break your interest rate, pay a break fee and refix for a longer period. This would give you certainty in fixing for a longer period with consistency in the repayments.

This brings forth some key points to consider:

• Would a break fee be payable?
• Can I afford the higher interest rate?
• What will happen if I do nothing?

Would a break fee be payable?

In a rising interest rate environment, there is unlikely to be an early repayment penalty for breaking your loans. The lenders can usually loan the money out at higher interest rates than you are paying, hence minimising, or eliminating the break costs of funds.

The calculation is lender-dependent and considers the lender’s actual costs incurred to break the loan as the lender locks in their funding at a rate as well.

Each lender will charge a break or admin fee for processing the paperwork, which varies between lenders, but starts from as low as $10 per loan.

Can I afford the higher interest rate?

Once you have the break fee quote and the new interest rates, the decision is: what do we lock in for? The answer will depend on your personal situation.

Your mortgage adviser will be able to tailor a solution that meets your needs and circumstances, considering affordability and certainty of repayments.

You may need to revisit your budget and look at ways to reduce spending or grow your income.

In some recent examples, where clients’ broke loans and refixed for longer:

The new interest rate was over 1% higher than they are paying now, but it suited their lifestyle to break and refix for a longer period to given them certainty in their repayments while the kids were at college.

The client broke their loan to refix for a period in which the client would have repaid the loan off in full, giving certainty of the rate for the remainder of the loan term.

What will happen if I do nothing?

In the last six months we have seen all rates go from being below 3% to all rates being above 3% (indeed only the 1-year rate is below 4%).

The opportunity cost of doing nothing can be very high; if interest rates continue to rise as expected, then in 6-8 months when you loan comes off fixed, the mortgage interest rates are likely to be a lot higher.

An example - a $500,000 loan for 30 years with the following interest rates, has approximate monthly repayments (rounded) as follows:

Now is the time to take action and contact your Lifetime financial adviser to get advice tailored to your needs and circumstances. The cheapest rate is not necessarily the best rate. 

Book Your Free 15 Minute Mortgage Chat Now 

Article By Greg Kerr

Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular investor’s objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.