Re-fixing Your Interest Rate: Should You Wait?

Date Published: 18 March 2022

Answering that question will require the use of a crystal ball and some tarot cards. Even though we are using those highly reliable tools you will still need to take everything with a bucket of salt. Case in point: prior to March 2020 most economists and industry experts were forecasting that New Zealand had pretty much reached the lowest point for interest rates and would soon see them stagnate or increase. Then Covid-19 hit. Those crystal balls hadn’t said anything about how you’d need to stock up on sweatpants, toilet paper and flour, or that as a result of government intervention you’d now be looking at re-fixing for a year with interest rates in the low 2%.

What’s happening in the mortgage market?

Having written that very long disclaimer, we can look into the future with a reasonable amount of certainty:

• We know that the housing market is cooling off. The availability of finance has been seriously affected by the CCCFA. Even with the government reviewing the regulations, it’s unlikely the banks will be able to loan significant amounts before July / August 2022.
• Covid-19 is spreading through our community, however nationwide lockdowns are looking to be a thing of the past.
• The Reserve bank increased LVR restrictions on investment properties to 60% from 1 May 2021. The Government doubled the brightline test and removed tax deductible interest.
• The Reserve Bank has (thankfully) not introduced Debt to Income Ratios however at least 2 banks are using these to at least filter applications.
• As interest rates increase (from an all time low of 2.09% to currently low 4%, the banks are increasing how they calculate affordability by using an interest rate of around 7%. Principal repayments must be calculated for as well as interest payments. While this may be frustrating for some buyers who could afford a lot more debt at today’s (comparitively) low interest rates, it will save many people’s homes if and when interest rates continue to go back up.

What’s happening with interest rates?

Floating rates have steadily increased over the past year as the Official Cash Rate (OCR) has increased. Expectations are that both will continue to increase over the next few years. Since the all-time interest rate low in June 2021 when 1 year fixed was at 2.09%, interest rates have almost doubled to a low 4%.

For 2022 (the short term) we’re betting the Reserve Bank will be focused on the record-high inflation. This means increased interest rates are likely. When that happens is anyone’s guess. With rates having gone up significantly already, they may have already had their run, or there may be more to come.

Should you break now or wait re-fix your interest rate?

Let’s say you have 6 months until your rate matures. The question a lot of people are asking is, should homeowners consider breaking their rate now or wait and risk rates going up even further? Here are the things to consider:

The premium you will pay if you re-fix your interest rate early

Let’s say you are currently on an interest rate of 2.2% and if you break your rate you will now be paying 4.2%. That means you will be paying a premium of 2% that you wouldn’t have been paying.

How long will you be paying the premium for?

The next question is, how long would you be paying the premium for? To figure out what your break-even rate is, you need to multiple the premium (above) by the amount of time (as a fraction of a year). Confused?

Above we used 6 months and a premium of 2% as an example so let’s use those numbers. 6 months is 1/2 a year, so the extra amount you will pay is 1% of the mortgage (2% x 1/2).

Based on these numbers, how do I know if I should break?

This is where you need to do some crystal ball gazing. You need to have a view on what interest rates are likely to be at the time your fixed rate is due to mature. In the example above, you would need a view on what the rate could be in 6 months.

If the premium is higher than the expected rate, you shouldn’t break your rate. If the premium is lower than the expected rate, you should consider it.

Let’s look at some numbers:

Continuing our example, you are breaking your rate of 2.2% and re-fixing at 4.2% 6 months early. You are therefore paying a premium of 1%. If you expect interest rates to be over 5.1% in the 6 months time (the new rate plus the premium), breaking your rate now would seem logical. You’re going to save money by breaking now and paying the premium. If you didn’t expect the rates to be higher than 5.1%, it’s not worth breaking now.

Something to remember about re-fixing your interest rate early

If you view the interest rates as, say, going to 5.1% in the next 6 months (in the example above), it’s worth remembering that is your break-even point. That’s just the amount that you come out just as good no matter which way you decide. Bearing that in mind, a rational decision-maker would need to have a view that the interest rates were going to be significantly higher than the break-even rate to make it worthwhile.

Will most people break early or wait?

At the time of writing, a lot of mortgages are still on the historically low rates and are due to mature at much higher rates – most will be up by around 2% at least. No matter whether your rate matures in 3 months or 2 years from now, because of the premium most people will be paying, you would have to have the view that interest rates are going to continue up at quite a steep rate, not only to the break-even point but beyond that too. Based on that, we would assume that most people wouldn’t choose to break their current rate.

What about break fees?

Break fees most often occur when the rate that you break is higher than the interest rate you are refixing at; for example, if you were on 3% interest rate and wanted to break to fix at a lower rate of, say, 2%. As most mortgages will be going the opposite way – from a lower interest rate to a higher interest rate – there probably won’t be any break fees. Having said that, it is always good practice to ask the bank to quote any break fees.

A big disclaimer

Your entire decision is based around your guess on where rates will be in the future and this is very difficult to forecast. Remember also that personal circumstances and future plans are very relevant when choosing how long to refix your mortgage for. Talk to a mortgage broker for advice specific to you.

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