Fixed vs Floating Rates

Fixed vs Floating Mortgage Rate NZ: A fixed rate locks in your interest percentage for a set term (e.g., 1-5 years), providing payment certainty but limiting flexibility. A floating (variable) rate moves up or down with the market (often linked to the OCR), offering flexibility to make lump-sum repayments without penalty but exposing you to rising costs.

For New Zealand homeowners, the mortgage interest rate is likely the single largest monthly expense. Choosing between a fixed term, a floating rate, or a combination of both can mean the difference of thousands of dollars over the life of your loan. In the volatile economic climate of recent years, understanding the mechanics of how New Zealand banks price these products is critical for financial stability.

What is the difference between fixed and floating rates?

In the New Zealand property market, the debate of “fixed vs floating mortgage rate nz” centers on the trade-off between certainty and flexibility.

When you sign up for a mortgage with banks like ANZ, ASB, Westpac, BNZ, or Kiwibank, you are essentially purchasing money. The price of that money is the interest rate. New Zealand banks source this money from different places. Fixed-rate funding is generally sourced from wholesale markets (swap rates), while floating rates are more closely influenced by the Official Cash Rate (OCR) set by the Reserve Bank of New Zealand (RBNZ).

Understanding this distinction is vital because it explains why fixed rates might drop while floating rates stay high, or vice versa. It is not just about the number on the page; it is about the terms attached to that number.

What are the pros and cons of fixing your mortgage?

Fixing your mortgage is the most popular option in New Zealand. Historically, the majority of Kiwi lending has been on fixed terms ranging from six months to five years. But why is this the default choice for so many?

Why choose a fixed rate?

The primary benefit of a fixed rate is budgetary certainty. When you fix your rate, you know exactly how much will leave your bank account every fortnight or month for the duration of that term. This is invaluable for families operating on tight margins or first-home buyers adjusting to the shock of homeownership costs.

• Protection from rising rates: If the RBNZ hikes the OCR or wholesale swap rates increase, your rate remains untouched until your term ends.
• Generally lower rates: In a typical yield curve environment, shorter-term fixed rates (e.g., 1 or 2 years) are often lower than the floating rate. This “discount” is offered because you are guaranteeing the bank your business for a set period.
• Set-and-forget simplicity: You do not need to watch the financial news daily. Your repayment is locked in.

What are the downsides of fixing?

While certainty is comforting, it comes at a cost. The rigid nature of fixed-term contracts can be a hindrance if your circumstances change.

• Lack of flexibility: Most banks limit how much extra you can pay off a fixed loan without penalty (often capped at 5% of the loan balance per year, or sometimes zero). If you receive a bonus or inheritance, you cannot simply dump it onto the mortgage to save interest.
• Break fees: If you sell your house or want to refinance to a lower rate before your term ends, you may be hit with an Early Repayment Adjustment (ERA).
• Missing out on drops: If interest rates plummet shortly after you fix for three years, you are stuck paying the higher rate while the rest of the market enjoys cheaper lending.

What are the benefits of floating (variable) rates?

Floating rates (also known as variable rates) are the ultimate tool for the disciplined borrower. While the headline interest rate is often higher than fixed alternatives, the structural benefits can save you significantly more in interest payments if utilized correctly.

The power of unlimited repayments

The defining feature of a floating rate is the ability to make lump-sum repayments of any size, at any time, without penalty. For self-employed contractors, commission-based workers, or those expecting a windfall, this is crucial. By paying down principal faster, you reduce the total interest charged on the loan.

Advanced features: Offset and Revolving Credit

Floating rates unlock advanced mortgage products that are not available on fixed terms:

1. Offset Mortgages: This links your savings accounts to your mortgage. If you have a $500,000 mortgage and $50,000 in savings, you only pay interest on $450,000. Your savings are accessible at any time, but while they sit there, they are effectively earning a tax-free return equal to your mortgage rate.
2. Revolving Credit: This acts like a massive overdraft secured against your house. Your salary goes directly into this account, reducing the daily loan balance and thus the interest charged. You then spend from this account as needed. It requires high financial discipline but is mathematically the most efficient way to pay off debt.

The risks of floating

The downside is volatility. Floating rates can change with little notice. If the RBNZ increases the OCR to combat inflation, floating rates usually rise almost immediately. This can lead to “payment shock” if you are not prepared for sudden increases in your fortnightly outgoings.

Splitting your mortgage: The hybrid approach

You do not have to choose just one. In fact, many mortgage brokers in New Zealand recommend a “split” or hybrid strategy. This involves dividing your total debt into different portions.

How does a split mortgage work?

Imagine you have a $600,000 mortgage. A split structure might look like this:

• $300,000 fixed for 2 years: Provides medium-term security.
• $200,000 fixed for 1 year: Takes advantage of a lower short-term rate.
• $100,000 floating (or offset): Allows you to use your savings to reduce interest and make extra repayments.

The benefits of “Laddering”

By fixing portions for different timeframes (e.g., 1, 2, and 3 years), you prevent your entire loan from coming up for renewal at the same time. This strategy, known as “laddering,” smooths out the risk of rate spikes. If rates skyrocket in one year, only a portion of your debt is affected, giving you time to adjust your budget.

What costs are involved in breaking a fixed term?

One of the most common questions regarding “fixed vs floating mortgage rate nz” is: Can I get out of my fixed rate? The answer is yes, but it may cost you.

Understanding the Early Repayment Adjustment (ERA)

Banks calculate break fees based on the difference between the rate you locked in and the current wholesale interest rate for the remaining term. If wholesale rates have dropped since you fixed, the bank loses money by letting you break the contract, and they will charge you an ERA to recoup that loss.

However, if wholesale rates have risen since you fixed, there is often no break fee (other than a small administration charge), because the bank can re-lend that money at a higher rate. It is crucial to ask your bank for a break fee quote before making any decisions; the figure can range from zero to tens of thousands of dollars depending on the loan size and rate movement.

How to choose the right strategy for 2024 and beyond

There is no single “best” rate. The right choice depends entirely on your risk appetite, cash flow, and financial goals.

Choose FIXED if:

• You have a tight budget and cannot afford for your payments to increase.
• You plan to hold the property long-term and want peace of mind.
• You believe interest rates are at a low point and are likely to rise.

Choose FLOATING if:

• You expect a large sum of money (bonus, inheritance, property sale) soon.
• You have significant savings that can offset the loan balance.
• You plan to sell the property in the near future.
• You believe interest rates are about to drop significantly and don’t want to lock in a high rate.

Ultimately, the hybrid approach offers the most balanced solution for the average Kiwi household. By keeping a small portion floating (equivalent to what you think you can save or pay off in a year) and fixing the rest, you get the best of both worlds: the security of a fixed rate and the flexibility of a floating one.