Knowing what type of mortgage to choose can be confusing particularly in the current economic climate.
The main types are fixed and floating. Both come with pros and inevitably both come with cons. Deciding which to choose depends on several factors including financial security, how quickly you want to pay off your mortgage and flexibility.
Fixed Interest Rate
As the name suggests a fixed interest rate agreed between you and your bank which is set in place for a set length of time. The length of a fixed rate can range from short term (around 6 months) up to 10 years.
Pros and Cons of a Fixed Interest Rate
Pros
You know exactly what you’re paying each month which helps with budgeting and financial plans.
You’re safeguarded against the fluctuating economy so even if interest rates rise your monthly costs will not.
Fixed rates can be lower than floating rates.
Cons
If interest rates do decrease you can’t lower your payments.
If you want to make extra or early repayments which weren’t included in the initial agreement you can face an early repayment charge.
Deciding How Long Your Term Should Be So, how to decide just how long your fixed rate should be for? Go for a longer term fixed rate if: - It looks like interest rates are going to increase. - You want to have financial certainty and know exactly how much you want to pay.
Go for a shorter term fixed rate if:
- It looks like interest rates are going to decrease.
- You want to sell your house quickly.
Floating Interest Rate
Unlike a fixed interest rate, a floating interest rate moves as the OCR or official cash rate does. Meaning that your payments change as the market adjusts. Pros and Cons of a Floating Interest Rate Pros
If interest rates decrease there is a potential for lower payments.
You’re not tied into a fixed length meaning that if you want to change to a fixed rate at any point you can.
There are no charges for making lump sum repayments of any size and at any time.
Cons
If the interest rate goes up then so do your payments which can put pressure on your budget. You need to be sure that you can make these increased payments.
There is a level of uncertainty as you can’t predict how much you will have to pay.
Whilst ultimately deciding which to choose is down to you, it’s important to get as much information as possible to help you decide.
Former Chief Economist at BNZ and now an independent economist, Tony Alexander says:
‘For the moment inflation rates and risks remain high and it will be some time before central banks express confidence about inflation. But eventually they will and when they do this is likely to cause some additional decline in wholesale borrowing costs which will feed through to some more cuts in fixed mortgage rates. Already banks in New Zealand have cut their fixed rates by between 0.2% and 0.4% from where they were a couple of months ago.
But people should not get optimistic about interest rates either falling away quickly or settling at new extraordinarily low levels come 2024 – 25.
I’d probably just fix one year, looking to take advantage of the easing of monetary policy I expect from late-2023. But I’d hopefully recognise the poor record we all have predicting interest rates since 2008 and look for opportunities to fix some of my debt longer sometime down the track. For the moment banks are competing for business with heavily discounted one year rates.’ (Tony’s View, 25th August, 2022)
If you’d like to discuss which option is best for you get in touch with Grace Team Accounting on 07 578 5416