What is a fixed rate mortgage?

A fixed rate mortgage has an interest rate that doesn’t change over an agreed period of time – six months, or one, two, three, four or five years. Fixed rates are typically lower than a floating rate.

Also known as a ‘fixed mortgage’ or ‘fixed home loan’, this type of mortgage is popular with New Zealand home owners. The main attractions are predictable regular repayments and lower interest rates. But before you sign up for a fixed rate home loan, it’s important to know exactly what you’re getting into. So here’s an overview of the main features, pros and cons to get you started.

What are the main features of a fixed mortgage?

As its name suggests, a fixed rate mortgage has an interest rate that doesn’t change over the agreed interest rate period (term). The available periods typically range from six months to five years. You can compare most of the lenders’ current fixed interest rates on our handy table of mortgage rates.

What are fixed interest rate agreements?

Choosing a fixed interest rate is like signing a contract with your lender. You agree to keep making the specified regular repayments until the fixed interest rate period ends. They agree to keep the interest rate the same for that period.

What happens when a fixed interest rate period ends?
At the end of your agreed fixed interest rate period, you can choose to re-fix with your lender for any of the available periods at their new rates. Alternatively, you can choose a floating (variable) rate or even switch to something like an offsetting mortgage. It’s up to you. If you do nothing, most lenders will automatically roll your mortgage onto their current floating interest rate and your regular payments will change to suit. When this happens, you can ask to re-fix at one of their new rates any time you choose.
Can you make extra repayments while on a fixed rate mortgage?
Most lenders will let you make an extra repayment of up to 5% of your loan’s balance (the total amount you still owe) each year. Some may only let you do this as a lump sum payment. Others will give you the option of increasing your regular fortnightly or monthly payments, but only up to the annual 5% limit. If you repay more than your annual limit, you’ll break the terms of your agreement and a penalty fee could apply(see next question).
What happens if you break a fixed interest rate agreement?
During the fixed rate period, if you repay more than the limit or move your mortgage to another fixed or floating rate, the lender will normally charge you a penalty fee. Each lender has its own name for this fee, such as ‘early repayment charge’ (ERC), ‘early repayment recovery’ or ‘early repayment adjustment’ (ERA).
Why do lenders charge an early repayment penalty fee?

It’s simply to recover the amount they’ll lose if you break the fixed rate agreement. Typically, they borrowed the money at a fixed wholesale rate for the agreed period and may not be able to re-lend it for the remaining time at the same rate, particularly if interest rates have fallen.

How much is an early repayment fee?

This will depend on how much extra you repay, how much you still owe, how long the fixed rate period has to run and current market interest rates. All of those factors tie back to the day you break. If you’re thinking of repaying some or all of a mortgage while it’s on a fixed interest rate, be sure to ask your lender what the penalty fee would be. They’ll only be able to give you an accurate amount for breaking on the day you enquire, but it’ll give you a good idea of how much to factor in.

What’s the difference between fixed and floating mortgages?

While a fixed mortgage interest rate doesn’t change, a floating interest rate can increase or decrease at any time. That means your regular repayments for a floating mortgage can also change.

Here are some other ways that floating mortgages are different to fixed ones:

Mortgage repayment flexibility

With a floating mortgage, you can make lump sum repayments at any time. Most lenders will also let you increase your regular payments to pay off your loan faster or decrease them to take pressure off your budget. However, decreases can only go down to a level that would still see you repay your entire mortgage within its original term, for example 25 years.

Freedom to switch lenders
When your mortgage is on a floating rate you can also repay it entirely. This means you could potentially switch to a different lender without early repayment charges.
Choice of mortgage type

Some types of home loans, such as offsetting mortgages and revolving credit mortgages, are only available with floating interest rates.

What are the advantages of a fixed rate mortgage?

Here’s a quick summary of why so many Kiwis choose a fixed interest rate:

Easier budgeting and less stress

A fixed rate mortgage offers the certainty of a consistent interest rate and predictable regular repayments for the agreed fixed rate period. This can make it much easier to budget, particularly at the beginning of a mortgage when things can be tight. It can also remove the stress of constantly worrying about interest rates rising (at least for the fixed interest rate period anyway).

Typically lower rates
The other attraction is that fixed mortgage interest rates are usually lower than floating rates. Many home owners try to ‘lock in’ a fixed rate when interest rates are low and expected to start rising. Paying a lower interest rate might mean you could afford the repayments on a shorter-term mortgage, such as 25 years instead of 30 years. That would probably save you thousands of dollars in interest over the life of your loan.

What are the disadvantages of a fixed rate mortgage?

Not everyone’s situation suits a fixed rate mortgage, so here are some potential downsides to consider before you dive in.
If interest rates fall, yours won’t
It’s possible to get stuck on a long-term fixed interest rate while market rates steadily fall. Predicting mortgage interest rates is never an exact science. As we have seen in recent times, it only takes a financial crisis or global pandemic to change the interest rate landscape overnight. However, in more normal times, if interest rates are predicted to fall it can pay to stay floating and ‘ride them down’, even if the floating rates are slightly higher.
Limited ability to make extra repayments
If you’re expecting a substantial salary increase or a financial windfall, such as a bonus or inheritance, a fixed interest rate mortgage can prevent you from immediately using that to repay your mortgage faster. The interest you receive for investments, such as term deposits, is always less than the interest you would ‘save’ by repaying some or all of your mortgage.
Difficult to switch lenders
Sometimes another lender will offer a special interest rate that would make switching worth the hassle. But the financial advantage may quickly disappear if you have to pay an early repayment penalty to your current lender, because you signed up to a fixed interest rate agreement.

Can you have more than one type of mortgage?

Most people split their total borrowing across more than one fixed interest rate period and/or more than one type of mortgage. It’s a smart way to put together a mortgage combination that suits your financial situation and goals.
Why choose more than one fixed interest rate?
One of the risks of a fixed interest rate is that the market rates are high when your fixed rate period ends and you might struggle to afford the new repayments. A potential way to reduce this risk is to put some of your borrowing on a short-term fixed rate and some on a longer one. That way you won’t have all your borrowing coming off its fixed rate at the same time. Of course, this doesn’t work as well if interest rates turned out to be low in the first example. It just evens out the potential risks and gains, because you don’t have all your eggs in one basket. Financial people call it ‘diversifying’.
Why put some of your mortgage on a floating rate?

People often do this to retain some ability to make extra repayments. For example, if you’re expecting your income to increase, you have an irregular or seasonal income, or you expect a windfall, you might put a corresponding amount on a floating rate and fix the rest. That can give you the best of both worlds – a good bit of certainty and lower fixed interest rate, plus the ability to repay your mortgage faster.

This strategy may also suit if you’re expecting a future drop in income from something like having a child or taking time off work to go travelling. It lets you repay a good chunk of your mortgage as fast as you can, then settle into the certainty of the remaining fixed mortgage.

Why combine a fixed mortgage with an offsetting mortgage?

This can be a very powerful strategy. In short, an offsetting mortgage lets you use the money in an everyday account to effectively reduce the balance of an offsetting mortgage. That means you pay interest on a smaller daily balance and repay your mortgage faster.

The trick is to have your income paid into the offsetting account to immediately reduce the effective loan balance. You then put most of your expenses on a credit card and automatically repay it in full at the end of each interest-free period. This keeps your offsetting account balance up and your effective mortgage balance down, for as long as possible.

An offsetting mortgage has a floating interest rate, which is usually higher than a fixed one. However, if you get the fixed vs floating split about right, your effective balance in the floating part will be very small for most of the time.

How to choose the best types of mortgage for you?

There are three main steps to this. One is being clear about your goals and appetite for risk. Another is setting a realistic budget and sticking to it. The third is to get trusted independent advice, from someone like an accountant or lawyer or mortgage broker.

Mortgage brokers are paid by the lender you choose from their recommendations, so there’s normally no extra cost for you. To help you find a good mortgage broker, we have a free Find a Broker service. It connects you with a qualified and experienced mortgage adviser from our hand-picked panel.

To learn more

DISCLAIMER: The information contained in this article is general in nature. While facts have been checked, the article does not constitute a financial advice service. The article is only intended to provide education about the New Zealand mortgages and home loans sector. Nothing in this article constitutes a recommendation that any strategy, loan type or mortgage-related service is suitable for any specific person. We cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you. Before making financial decisions, we highly recommend you seek professional advice from someone who is authorised to provide financial advice.

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