When you’re buying a home or refinancing in New Zealand, one of the biggest decisions you’ll face is whether to choose a fixed or floating interest rate for your mortgage. The choice between these two options can feel like confusing, especially in today’s economic climate where interest rates are subject to constant change. But fear not! By the end of this post, you will have a reasonable understanding of what fixed and floating interest rates are, how they work, and how to make the best decision for your financial situation.

Fixed Interest Rates: Predictability in Uncertain Times

A fixed interest rate is exactly what it sounds like—an interest rate that remains constant for a specified period, typically ranging from one to five years. Once you lock in your fixed rate, your monthly mortgage repayments will remain the same for the agreed duration, regardless of any changes in the official cash rate or market conditions.

Pros of Fixed Interest Rates:

• Certainty: Fixed rates offer predictability. Knowing exactly how much you’ll pay each month helps with budgeting and financial planning.
• Protection Against Rate Increases: If interest rates rise, your fixed rate remains unaffected. This can save you a lot of money if rates increase significantly during your fixed term.
• Peace of Mind: You won’t need to worry about fluctuating repayments, which can be particularly reassuring in uncertain economic times.

Cons of Fixed Interest Rates:

• Lack of Flexibility: If interest rates drop, you’re stuck paying the higher fixed rate unless you refinance, which can come with break fees.
• Less Flexibility: Fixed rates can lock you into a set payment schedule, offering less flexibility if your financial situation improves.
• Limited Benefit from Rate Drops: If market interest rates decrease, those on fixed rates won’t benefit from the reduction, potentially missing out on savings.

Floating Interest Rates: Flexibility with a Risk

A floating interest rate, also known as a variable rate, can change over time in response to shifts in the market or the Reserve Bank of New Zealand’s official cash rate (OCR). Your mortgage repayments can increase or decrease depending on how these rates move.

Pros of Floating Interest Rates:

1. Flexibility: Floating rates allow you to make extra payments without penalty, which can help you pay off your mortgage faster and save on interest.
2. Benefit from Rate Drops: If interest rates decrease, your mortgage repayments will also go down, potentially saving you money.

Cons of Floating Interest Rates:

1. Uncertainty: Because floating rates can change, your repayments might fluctuate, making it harder to budget.
2. Potential for Higher Costs: If rates rise, your repayments will increase, which could strain your finances.

Let’s bring these concepts to life with a couple of real-world examples that illustrate how the choice between fixed and floating rates can play out.

Case Study 1 – Sarah and the Power of Predictability

Sarah, a first-time homebuyer in Auckland, was excited but nervous about her mortgage. She had recently started a family, and financial stability was her top priority. With interest rates being historically low, Sarah decided to lock in a five-year fixed rate of 5.5%. She knew that her mortgage payments would remain consistent for the next five years, giving her peace of mind as she adjusted to her new responsibilities as a homeowner.

Fast forward two years, and interest rates have risen. Sarah feels relieved every time she hears about the rate hikes on the news, knowing that her decision to fix her rate has saved her hundreds of dollars each month.

Case Study 2 – Matt’s Floating Flexibility

Matt, a seasoned investor with multiple properties, opted for a floating rate when purchasing his latest rental property in Wellington. He liked the idea of making lump-sum payments without penalties and hoped to capitalize on any rate drops in the near future. His mortgage rate started at 6%, but within six months, the Reserve Bank lowered the OCR, and his rate dropped to 5.2%.

Matt quickly took advantage of the lower rates, making extra payments whenever he could. However, a year later, the rates began to climb again, reaching 6.5%. Matt’s repayments increased, but his rental income provided a buffer, so he wasn’t too concerned. In the end, he was happy with the flexibility the floating rate provided him, despite the fluctuations.

Fixed vs Floating in Today’s Economic Climate

In 2024, New Zealand’s economy is navigating through a period of uncertainty. Interest rates have been volatile, reflecting the global economic pressures and the Reserve Bank’s efforts to control inflation. Homebuyers and investors are increasingly cautious, weighing the pros and cons of fixed and floating rates more carefully than ever before.

As of August 2024, fixed mortgage rates in New Zealand range between 5.6% and 7%, depending on the term and the lender. Floating rates, on the other hand, hover around 7% to 8.5%, with room for variability depending on the OCR.

Given this environment, the choice between fixed and floating rates boils down to your financial goals and risk tolerance.

• If you’re like Sarah and value stability, a fixed rate might be the way to go. The predictability of your payments can provide peace of mind, especially if you’re concerned about further rate increases.
• If you’re more like Matt and have some flexibility in your budget, a floating rate could offer benefits, particularly if you’re expecting rates to drop or if you plan to make extra payments on your mortgage.

Making Your Decision – Key Considerations

When deciding between fixed and floating mortgage rates, consider the following:

1. Your Financial Situation: How comfortable are you with the possibility of fluctuating mortgage payments? If you have a tight budget, a fixed rate may provide the security you need. If you have more financial flexibility, a floating rate might offer the potential for savings.
2. Economic Outlook: Keep an eye on economic indicators, such as the OCR and inflation rates. If experts predict rising rates, fixing your mortgage could be a smart move. Conversely, if rates are expected to drop, a floating rate might be more advantageous.
3. Your Long-Term Goals: Are you planning to stay in your home for a long time, or is this a short-term investment? Your timeline can influence whether a fixed or floating rate is better suited to your needs.
4. Break Fees: If you’re considering a fixed rate, understand the potential costs of breaking your mortgage before the term ends. Life happens—whether it’s upgrading to a new home or dealing with unforeseen financial changes—so it’s essential to factor in these possible expenses.
5. Consult a Mortgage Adviser: If you’re still unsure, consulting a mortgage adviser can provide tailored advice based on your specific circumstances. They can help you weigh the pros and cons and choose the best option for your situation.

Blended or Split Mortgages – Best of Both Worlds?

If you’re finding it difficult to choose between fixed and floating rates, you might want to consider a blended or split mortgage. This approach allows you to split your mortgage into two parts (or more), with a portion on fixed rate and the other on a floating rate. This strategy provides a balance of stability and flexibility, allowing you to benefit from rate drops while also protecting against significant rate hikes.

For instance, you could fix 70% of your mortgage and leave the remaining 30% on a floating rate. This way, you enjoy the predictability of fixed repayments while also being able to make extra payments or benefit from any rate decreases on the floating portion.

Final Thoughts: The Importance of Making an Informed Decision

The decision between fixed and floating mortgage rates is one that shouldn’t be taken lightly. The choice you make will impact your financial well-being for years to come. By understanding the advantages and disadvantages of each option, considering your personal circumstances, and staying informed about the broader economic environment, you can make a decision that aligns with your financial goals and gives you peace of mind.

Remember, there’s no one-size-fits-all answer. What works best for Sarah might not be ideal for Matt, and vice versa. Take the time to assess your situation, consult with experts if needed, and make the right decision for you, we at Financial Advisers NZ are just a call away.

For more detailed advice and up-to-date information on New Zealand’s mortgage rates, check out these resources:

• Reserve Bank of New Zealand – Official Cash Rate
• Sorted – Mortgage Calculator
• Interest.co.nz – Mortgage Rates

By staying informed and considering all your options, you’ll be well-equipped to make a choice that supports your financial future in New Zealand’s ever-changing landscape.

• Names have been changed to protect privacy, images are used for reference only.