A fixed or floating mortgage - do you choose one or the other, or mix it up?
Should I choose a fixed rate mortgage or stay floating? It’s one of the most common questions for every home buyer, whether they’re looking for their first home or not.
If you’re a first home buyer thinking about this question, then you will already have made it through the various initial stages towards getting the key to your dream home. You’ll already know what kind of house you can afford, and you’ll have your deposit ready. You will have also completed the pre-approval process meaning you’re ready to go.
Now picture this - you’ve found the home you want, had it surveyed, and you may have even made an offer. The big question now is how do you make your mortgage work for you?
In this blog, we are going to be looking at the two main types of mortgage: 1) fixed rate and 2) floating rate. Read on to learn more about what they are, how to use them to your advantage, and which one fits best for your situation.
What is a fixed rate mortgage and floating rate mortgage?
A fixed rate mortgage has an agreed interest rate with a term, or period of time, which can last for as short as six months, or as long as five years. This means you will pay a certain amount to the lender every week, fortnight or month, for the duration of the term.
The advantage of a fixed rate mortgage is that you know exactly what your repayment is going to be from the get go. This will comprise paying the interest as well as some of the principal, or the actual amount of the money you’ve borrowed. This means over time your loan will decrease in size. With fixed rate you’ll know what you’re committed to, so you’ll be able to better plan your monthly and annual budget.
On the other hand, with a floating rate mortgage, the interest rate is variable. It can either go up or down as the national economic situation changes. Floating interest rates are decided by lenders, such as banks, and reflect the Official Cash Rate (OCR) set by the Reserve Bank of New Zealand. Over recent years the OCR has remained very stable and historically low, however, this hasn’t always been the case.
As its name implies, a floating rate mortgage is flexible and you don’t have any control over it. However, a benefit is because it hasn’t been fixed you can make payments whenever you want. This can be beneficial to home buyers who have some spare cash at the end of the month - a little amount paid off now and again can save large sums of money spent in additional interest, in the long run.
Fixed vs floating
One type of mortgage is not necessarily a better option than the other. Rather, they are both useful depending on your specific needs. Each has a unique set of advantages and disadvantages:
Fixed rate benefits
With a fixed rate, your interest rate does not change for the duration of the loan. You will sign an agreement at the beginning, so you’ll know exactly how much your repayment is going to be, which means you can plan. Probably the best advantage is after agreeing to it, you can forget about it until the end of the term.
In case something happens with the economy and interest rates for the house market rise, your loan won’t be affected. On a fixed interest mortgage, you’re protected because your rate will stay the same. You can also use fixed mortgages to lock in an interest rate if the market rates are rising.
○ Plentiful options
The fixed rates and repayments of this type of mortgage will make it much easier for you to shop around and compare loans from different lenders and choose which one is best for you and your budget.
Fixed rate mortgages are popular in New Zealand, and it’s not hard to see why. A fixed rate loan makes budgeting easy for homeowners, especially those who are buying a home on a tight budget. Fixed rates give the homeowner peace of mind.
Fixed rate disadvantages
Just as you are not affected by rising interest rates, you also won’t benefit if interest rates fall. For you to reap that benefit, you’d have to refinance your loan, which requires paying the costs associated with refinancing.
○ Break fees
If you decide to sell your home before your term ends, you will need to pay a “break fee”, which is a cost charged by your lender for the early repayment of your mortgage.
Floating rate advantages
Since there is no fixed interest rate, you have the ability to make changes to your loan without having to pay additional costs. An example of this would be to leave your home loan floating until you fix your home loan at a later date.
With a floating rate mortgage, you can also pay the loan off using lump sums or even by changing your loan term, and you can also make principal payments. Interest only loans are available on both floating and fixed rate loans, on a case by case basis, subject to credit approval.
For instance, for investment properties its very common to have an interest only loan because there’s no tax benefit from paying off the principal. But it’s very rare to have an interest only loan on your private home as it raises questions from the lender as to why a borrower is unable to pay off some of the principal. The lender will always have an eye on any risk associated with its lending.
○ Impact of low rates
If your interest rate goes down, then so do your repayments. This allows you to save more money while simultaneously paying off more of your loan, which can result in a lot of savings over the period of your loan.
○ Use floating to consolidate
You can use a floating rate to consolidate other more expensive loans, by borrowing more against the value of the house, as values rise.
Floating rate - disadvantages
○ Non-budget friendly
Yes, a floating rate is a flexible option, but it comes with uncertainty. If you are on a tight budget, you’ll have trouble figuring out how to make higher repayments should rates go up, which can happen at inopportune times in your life. Crystal balls are difficult to come by!
○ Fluctuating interest
Unlike a fixed rate loan, your rate under this type of mortgage is not protected. If interest rates go up, so do yours, and so do your repayments.
At this time, floating rates are higher than fixed rates. However, there is no guarantee that it will stay that way. History shows floating rates have been higher than fixed rates.
Which one is right for you?
There’s no need to pick one option over the other - it’s not an “either or” question, since it depends entirely upon your personal circumstances.
Probably the best advice is to split your loan, so that you can enjoy the advantages of both fixed and floating. This way, you get the rate protection attached to a fixed rate mortgage while also benefiting from the flexibility provided by a floating rate mortgage.
Splitting does not necessarily mean into two - dividing a loan into different fixed rates and then leaving a proportion floating so you can pay off some of the lending when you can is a good strategy. This is all about hedging your bets on what may happen to interest rates in the future, whether they go up or down.
At Taurus Home Loans, we talk to hundreds of people about their own circumstances and how they want to model their mortgage to suit them, so they can own a home while also living the life they want. A mortgage is meant to enable you to own a home, and shouldn’t be a burden more than it needs to be.
We love nothing more than helping you get the keys to your dream house and sorting out a mortgage for your needs - so why not give us a call?
Mobile: 027 352 6262
Phone: 03 366 6087
Posted 16 May 2018