Should you break and reset your mortgage rate?

Fixed-rate mortgages have risen a whopping 80 per cent in the past 12 months. They’re the mainstay of most Kiwi homeowners, and it’s likely most of us are wearily waiting for the next maturity date and bracing for the inevitable fate.

Right now, three-year fixes are sitting below 5 per cent. Despite the increases, that’s not historically expensive and borrowers need to get practical quickly.

It’s important to weigh up two things right now:

• A lock-in for a longer period such as three or five years.

• Break an existing cheaper fixed-rate and reset into a longer more expensive three- or five-year structure (there is some sense in this).

Looking back

Let’s wind the clock back. If you had a crystal ball in 2021, what bottom-scraping fixed rate deal could you have locked in?

Our Reserve Bank monitors average mortgage rates at the end of each month and here’s where the historical lows were:

• One-year fixed: 2.21 per cent in June 2021

• Three-year fixed: 2.73 per cent in February 2021

• Five-year fixed: 3.01 per cent in February 2021

During 2021 we saw lowest-of-a-lifetime mortgages. This week, the average one-year fixed rate is 3.98 per cent (1.77 per cent higher).

The average three-year sits at 4.9 per cent (2.17 per cent higher) and the five-year comes in at 5.33 per cent (2.32 per cent higher), although ANZ and ASB are skewing the five-year with uncompetitive pricing. That’s roughly an 80 per cent increase in interest costs across the board.

Adding perspective

Most of us won’t be suffering higher repayments right now, as we’re sitting on old fixed-rate deals.

It’s likely those with maturing one-year rates will notice the uptick, but if you are coming off a three-year fix this month, you’ll see some similarity between 2019 and 2022. Back then the three-year offers were in the 4 to 5 per cent range during the year.

Very few of us get our timing right and roll into the next deal at the exact time interest rates hit all-time lows. It feels like a matter of luck, because we need to wait for our last fixed rate to expire – or do we?

Break and reset

Would you consider breaking your fixed-rate mortgage early? For most people that would mean exiting a cheap deal and taking on a more expensive fixed-rate today. Or it could mean locking in a similar rate but securing it now.

It sounds like financial craziness.

Deciding to break-and-reset revolves around your risk tolerance of inflation driving interest rates even higher.

Will it cost me break fees?

Possibly, but in the current market it could be zero or very little. When closing out early, the fixed rate is offset against the investment rate for the remaining time on the loan.

This is at a wholesale level (not term deposit rates). If interest rates have been rising, the maths can give you a positive cashflow. But given the bank will inflict administration costs and a break fee, it’s unlikely a retail customer will ever see a net payment. Regardless, negligible costs help the decision-making process.

But why would I do it?

It seems counterintuitive to close out a lower fixed rate and opt for a higher one, but it’s not as vanilla as that.

We need to weigh up short-term lower costs against medium-term certainty and avoiding any further rate rises.

If you have a year or less remaining on a fixed rate, it could make sense to bolt early and lock in a new deal to protect yourself. It’s a great time to discuss this with a mortgage broker.

Could interest rates increase further?

The local cost-of-living crisis and wage pressure increasing is well documented. But we can’t overlook the force of imported inflation.

It’s becoming a catastrophe we have no control over. There are supply chain issues holding up production and delivery, freight costs remaining high and China’s stance on Covid-19 slowing factory production.

The Ukraine war adds one layer too many. Even with a quick settlement on the Donbas and neutrality, the war has created a commodity crisis, an energy crisis and a trade war, which is hard to unwind quickly when war crimes are fresh and trust won’t resolve overnight.

A pandemic iced with Putin adds too many layers of imported inflation to the cake. It’s starting to feel implausible that both will simultaneously unwind in a neat fashion.

What’s the downside?

If we’ve got this wrong, you’ll lock in a higher mortgage rate for longer than necessary. If inflation slows, mortgage hikes will be more limited and a different rate structure would have given a cheaper deal. For some people, splitting a mortgage over several fixed time periods feels better.

What’s the upside?

Certainty. If you can afford a three-year fixed rate at 4.69 per cent (SBS) or five years at 5.09 per cent (TSB, BNZ and Westpac), you’ve protected against the risk of imported inflation continuing for longer than expected.

Everything with money is about taking a view, and to my mind there are now too many varied sources of inflation risk and more complex entanglement. I’d rather see borrowers with longer periods of certainty in the next three to five years by securing current rates as quickly as possible.

Time for a three-year fixed rate mortgage?

Here’s how the banks compare on a three-year fixed mortgage for those owning at least 20 per cent of a home, with the average coming in at 4.9 per cent:

• SBS: 4.69 per cent

• TSB: 4.75 per cent

• Kiwibank: 4.79 per cent

• BNZ: 4.79 per cent

• Westpac: 4.89 per cent

• ANZ: 5.15 per cent

• ASB: 5.25 per cent

Janine Starks is the author of www.moneytips.nz and can be contacted at moneytips.nz@gmail.com. She is a financial commentator with expertise in banking, personal finance and funds management.