Fixed vs floating: which is best?

Shoes in front of three arrows on the road, going in different directions

This is a common question among first home buyers, especially those who go to a bank directly for a mortgage.

Most people (90% of the market) settle on fixed mortgage rates – or a combination of fixed and floating – because fixed rates are lower than floating rates.

However, it’s important to remember a mortgage is about more than just rates. While it may be tempting to “shop the market” to find the lowest possible rate, it’s always best to keep the bigger picture in mind.

So, which mortgage rate term is the best? Let’s take a look at the pros and cons of both fixing and floating.

Fixing your mortgage

It’s true that fixing your mortgage will result in lower repayments because the interest rate is lower than a floating rate.

Fixing also allows you to budget correctly. You’ll know exactly how much is going to the mortgage after each paycheck.

The trade-off is that by locking in a rate, you can’t make lump sum or non-scheduled repayments without incurring early repayment fees.

It’s worth noting however, that when a fixed term expires, a bulk repayment can be made on the day of expiry without penalty. This is because it effectively reverts to floating, and from there it can be refixed at the lower rate.

Floating your mortgage

Repayments are higher on a floating mortgage, but you gain the flexibility to pay off lump sums as often as you wish, or pay back the entire loan early, without any early repayment fees.

It can be a smart option if you know you’ll come into extra cash.

Fixing and floating (a combination)

A third option (and the most popular in New Zealand) is to fix a portion of your loan and float another. This gives you an element of predictability, but also some flexibility. Having a portion on floating means any surplus funds can be used to make lump sum payments without penalty, while keeping the rest of the mortgage on a lower fixed rate.

The most popular fixed-rate term is the 2-year term, as it tends to be the term that banks compete the most aggressively on.

In the current market, you can expect the 1-year and 2-year terms to be the lowest available.

Choosing between 1-year and 2-year fixed terms

If you're able to make lump sum payments regularly, then having a 1-year term may make sense. It'll allow you to make more lump sums into your fixed loan sooner.

However, if your mortgage is relatively high and having lower and regular repayments is more suited to your budget, then a longer term will provide more certainty.

So, which is the best mortgage rate term?

The best mortgage rate term is different for everyone. The best term for you depends on your unique financial situation; it’s not all about the rates.

Take the time to understand your financial situation thoroughly, ideally alongside an adviser with knowledge and experience.

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