Is it worth breaking your fixed loan while interest rates are low?

Top view of shoes on concrete, painted arrows symbolising decisions

We are currently seeing the lowest interest rates ever in New Zealand and rates look like they will stay low for a very long time. Those who have locked in a fixed rate mortgage at a higher rate might be asking if it’s worth breaking and fixing at a new rate?

Earlier this week our answer would have been No. Typically break fees offset any benefit of changing. That said, what can make a difference is the “cash contribution” borrowers get when they switch lender.

With rates predicted to go lower, breaking an existing fixed rate mortgage is only going to get more expensive. Last Wednesday the Reserve Bank left the OCR unchanged on one percent and wholesale rates immediately spiked up. That spike will lower break fees in the short-term and might make breaking your existing loans slightly more palatable.

What does this mean going forward?

Business confidence remains low. Firms are worried about the tight squeeze on profit margins, and banks are not immune either. It’s harder for banks to make money when interest rates are very low. So, we might be seeing the bottom for mortgage rates. I would not be surprised to see a small increase in rates as banks try to maintain profits. It’s going to get harder for banks with the Reserve Bank also wanting them to increase their capital and higher costs from new regulations and more compliance.

Is it worth waiting until next year to break?

If, as we predict, banks begin to raise mortgage rates next year, it may be worth acting now to make the most out of these low rates, especially if wholesale rates increase a bit and reduce your break fee.

Can I avoid paying a break fee?

There is no way to avoid a break fee if your mortgage is currently fixed. The only way to avoid a break fee will be waiting for your current fixed term to expire, but depending on when that is, you’ll have to accept that circumstances and rates can change in the meantime.

A break fee isn’t really a cost. Generally, the amount you save on dropping to a lower rate will offset the break fee, making it cost neutral.If your fixed rate maturity isn’t far away, then we would advise to wait. Some lenders will allow you to lock in a rate 60 days out from the end of your fixed-term contract.

If you've been with your existing bank for less than three years, then refinancing is not really an option. Your bank will claw back any cash contribution it gave you upfront, and that will offset the benefit of refinancing. If you’re outside the three-year mark then it might be financially beneficial.

If I do break my mortgage, how long should I fix for?

Things could change if banks start to increase their mortgage rates. Right now, we think the best fixed term is two-years. Banks are currently offering 3.45% for two years with SBS offering 3.39% (but with a lesser cash contribution). These rates aren’t likely to change over the next few weeks and are an excellent medium term that will allow you to monitor what the OCR does over the next 12 to 24 months.

ANZ predicted that the OCR could be as low as 0.5% by May 2020. However, we will wait for their next Economic Review as this may have changed given the no change in the OCR by the RBNZ last week. If economic activity continues to remain low, a two-year fixed term isn't too long of a commitment for you to take advantage of rates if there was another wave of rate cuts.

Taking action

From here, if you still have questions around whether or not you should break your current fixed term and refix or refinance, then talk to an expert. Each bank will have its unique algorithm involving the wholesale rates to calculate your break fee. What you'll find with most banks is that they won't offer a cash contribution to keep or retain existing business, and unless you're able to wear that break fee yourself, then refinancing may be a good option. Talk to our like-minded friends at Squirrel by calling them on 0800 627 044.

How does this impact me?