As recent history has very clearly shown us when it comes to mortgages and interest rates, predicting the future is very tricky. On top of this, many of us find thinking about our mortgage changes, rollovers and refixes just headache-making. Many of us prefer to not give too much thought to the mortgage once it’s been approved and put a “set and forget” approach in place.
But there can be financial advantages to breaking your fixed-term home loan to refix or refinance your mortgage early so you can take advantage of movements in the market.
Why would I break my mortgage to pay more money?
Typically, a mortgage is refixed at the end of your loan term, but it can make sense to break a loan early. How much of an advantage there will be in breaking your mortgage early depends greatly on what type of mortgage you’re on, when your current term ends and your view on interest rates and how much you think they will increase.
A lot of mortgages in New Zealand are due to mature soon. According to an April article in Stuff quoting Reserve Bank data, $68 billion of home loans were due to be refixed before October 2022, with another $100b due to be refixed within six months to a year from then.
Many of the mortgages about to mature are on fixed rates, so if you are about to come off a three-year term, the new rate you’ll have to pay won’t be too dramatically dissimilar to what you were paying in 2019 when the three-year mortgages were in the 5 per cent range.
But what if you have more recently got a mortgage that won’t mature for another one year or so? Would you be better off breaking an existing loan to refix for a longer more expensive three- or five-year term before interest rates rise too much?
Breaking and refixing
For most people, breaking a fixed-rate mortgage early would mean bailing on a cheap deal to take on a more expensive fixed-rate, or locking in a similar rate but securing it now as opposed to when the mortgage matures.
Thanks to Covid-19, supply chain issues, high demand, high freight costs and the Ukraine war, we have a cost-of-living crisis and wage pressures that could drive inflation even higher thereby pushing up interest rates further. The two questions to consider therefore are how much higher will interest rates go and what is your break-even point?
What’s a break-even point?
At first glance, it might seem obvious, but the point at which you come out just as well off no matter whether you leave your mortgage as is or refix early is the break-even point.
Let’s say you currently have a mortgage with an interest rate of 3.5% and if you break your rate and refix, you could be paying up around 5.5%. That is a premium of 2% that you wouldn’t have been paying if you’d kept your current mortgage.
The next question is, how much the interest rates will go further up by the time your loan comes to maturity or renewal and whether you can afford the mortgage repayments at the expected rates at that time. For example, if the mortgage rate is expected to go up another 1% to 6.5% then it doesn’t make sense to break the loan now and pay extra 2% when you will only save 1% further in interest rate by breaking the loan early and fixing it now. However, if you believe you can afford the mortgage repayments at 5.5% but not at 6.5%, then you may want to bite the bullet and fix the loan earlier than the current maturity date of your loan.
The same logic applies to 3 -5-year mortgages. You would need to believe that interest rates were going to be significantly higher than the break-even rate to make it worthwhile.
What are break fees?
You also need to factor in break fees – the cost the bank incurs when they break a fixed-term loan that they pass on to you – and how much they will be.
Break a loan early, you could incur a break fee. You may also incur an administration fee and legal fees to transfer your title as security across should you move to your new bank. Having said that though, break fees are most often charged when you break a mortgage to go from a lower interest rate to a higher interest rate. As you’d be moving the opposite way, there probably won’t be any break fees, but our mortgage brokers would always check on your behalf.
What does our crystal ball say?
If we gave our imaginary crystal ball a rub, we reckon it would tell us that the one-year home loan interest rate will be sitting at 6% by mid-2023, the two-year rate will be at about 6.5% and the five-year rate will be around 8%. If we rubbed it again, we think it would tell us that retail interest rates will again settle to just above 4% by mid-2026.
The future’s not ours to see
Interest rates are famously hard to predict and very few people get the timing exactly right. Breaking your mortgage early will be dependent upon what you believe interest rates are likely to be at the time your fixed rate is due to mature and what the rate could be in 6 months to five years.
It comes down to your risk tolerance as moving from a lower fixed rate and opting for higher monthly payments certainly can seem counterintuitive.
Short-term costs and longer-term odds
Before making any changes, it is very important to look carefully at the costs and possible savings. Weigh up short-term lower costs against medium-term odds, and it could very well make sense to break your current mortgage early and lock in new terms to protect yourself. Or you may feel more comfortable splitting your mortgage over several fixed periods. As they’ll mature at different times, you won’t be as exposed to interest rate movements.
The next move with your mortgage
Times of economic uncertainty are a great time to call upon the skills, contacts and experience of our mortgage brokers. To discuss your situation, especially if you’re feeling a little overwhelmed by the prospect of rising interest rates, simply get in touch.
If you’re trying to decide what your best next move is going to be with your mortgage, we’ll work with you to understand your needs and find a smart way forward to potentially save money in the long term. We’ll help you secure the best deal by negotiating with lenders on your behalf.
We’re here to help! Call Global Finance today, and we’ll talk you through all the best mortgage options available.
**These are general guidelines and are by no means a reflection of bank or lending policies