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On the 9th of October 2024, the Reserve Bank of New Zealand decided to reduce the Official Cash Rate (OCR) by 50 basis points, bringing it down from 5.25 percent to 4.75 percent. This decision was made in response to slowing inflation and a subdued economy.
A 0.5% drop is significant, signalling that the Reserve Bank wants to inject some momentum back into the economy quickly. I think we can all agree on that. The only losers here are those who have money to invest in fixed interest funds. The money markets were leaning towards this action, so most of this drop had already been “priced into” the cost of the banks getting their money. However, we assume this drop will give the banks confidence to keep lowering their fixed home loan rates. The word on the street is there are more drops to come (perhaps another 0.5%) so we wait for the next OCR announcement on 27th November.
As of the time of writing (18th October), good discounted fixed rates look like this:
6 months 6.4%
1 year 5.6%
2 years 5.6%
3 years 5.6%
Bear in mind, banks' interest rates are “leapfrogging” their way down, so when you read this, there is every likelihood these will be lower.
Given the current predictions and modelling, very few people are fixing for longer than a year right now. They are willing to pay slightly higher interest now for a chance to refix in 6 months or a year. For most people, that makes sense. As always, everyone’s situation is different, so do talk to us first, and we can guide you through the options.
Given the current predictions and modelling, very few people are fixing for longer than a year right now.
However, for some, we do need to talk Break Costs.
This hasn’t been an issue for the last couple of years because when interest rates are rising, banks generally won’t charge break fees.
Let me explain. When you fix a loan, you agree to “lock it in” for a period of time. You have made a contract with the bank to pay a set interest rate for a set period. (Small side note: When you tell us as your mortgage broker to fix a rate, we pass that on to the bank, and from that stage, it can cost you to change your mind. So, be sure you have made your mind up before you give instructions to us or your bank). Legally, banks do need to let you out of that contract, but they have the right to pass on the costs of doing so. The “break fees” are that cost.
An example might help. If you agree to fix a loan for 1 year at 7%, you agree to pay the bank that interest rate for that period. Let’s say it is 6 months into that 1-year fixed period, and you want out of that contract for whatever reason, and rates have dropped to 6%. Note that banks don’t care if that is because you need to sell your house or you are simply chasing a better rate. I have never heard of a bank not enforcing a break fee. Instead of the banks getting 7% for the last 6 months of the contract from you, when they get that money back and lend it out again, they can only lend it out at 6%. They get 1% less for those 6 months, and that 1% for 6 months is what they will charge you in break fees. That is their loss. You can see the longer it is until your fixed rate expires and the bigger the interest rate drop (and of course the bigger the loan), the bigger the break fee will be.
Now, it isn’t quite that simple, as the calculation isn’t based on the rate you are paying, but rather how much it cost the bank to acquire the money they lent you (i.e., the wholesale interest rates) at the time you fixed vs. the time you break. So, the equation is complex (have a look for it in your loan documents if you are that way inclined), but the retail rates you are paying aren’t a bad estimate.
In the current dropping interest rate environment, make sure you fix for a period that you can commit to. Realize rates are very likely to keep dropping for the next year or so, and there is a trade-off you will need to manage.
Realize that if you want to get a better rate, the break cost will pretty much equal the savings you will make with a lower rate (and you need to have the cash to pay the break fee upfront). If you think rates are really going to drop away and you are a “betting person,” you could break your loan now, pay the break fee, stay on a floating rate for a period (costing you more in the short term), and fix down the track, hoping rates will be lower again. If this is something you want to consider, there is some math to be done as to how long you stay on a floating rate and what rates will need to drop to, to “win” in this scenario.
Break costs change daily and can increase quickly. Your bank will calculate the break cost on a daily basis based on the wholesale interest rate (and how long until your fixed rate expires). Wholesale rates (the rate the bank “buys” their money at) are volatile, so just because you have been given a break cost today doesn’t mean that will be the cost in a week. So, you need to act quickly if you do want to break.
If you are selling a house within a fixed rate period (i.e., you have to break a fixed rate when you sell), there is not a lot you can do about estimating the break cost at settlement apart from guessing how much further rates will drop. Today’s break cost almost certainly will be different than in (say) 6 weeks’ time when your house settles. Because of this, do work on a very conservative figure when you are doing your math. If you need certainty and you have some cash available now, it might even be worth breaking a fixed loan now and being on a higher floating rate until your house settles.
The bank will give you today’s break cost over the phone. Some banks' internet banking apps are smart enough to give you this if you ask it to make a “lump sum” payment on a fixed loan (ask it to make a lump sum for the whole amount, but of course, don’t go through with the request).
If you want an estimate of what the break fee will be without losing your will to live while listening to Brooke Fraser on repeat waiting for a real person to talk to, here is a pretty good break fee calculator that will estimate today’s break fee for you.
Breaking fixed loans is something that is really hard to give you advice on as it involves making assumptions about the future, and of course, we don’t know what the wholesale interest rate will be in 6 weeks’ time. However, we are happy to run through some scenarios with you. In this case, it is better to be the fence at the top of the cliff rather than the ambulance at the bottom. Before you choose to fix a rate, let’s spend some time working through the options with you so we don’t need to have the “break fee” conversation.
Brendon.
Brendon Ojala (FSP119244) is a Financial Adviser with Velocity Financial (FSP95466). No investment decision should be taken based on the information in this blog alone. Please see our disclosure statement on our website.
About Brendon:
Hi, I'm Brendon, one of the owners and advisers at Velocity Financial. I have been giving advice on mortgages and insurances at Velocity for around 15 years, and it is great to be able to work with people to achieve their financial goals. Prior to giving money advice I worked as a youth worker and managed teams for a not for profit organisation. I live with my wife and one of my sons (the other one only stays when he needs food) in Berhampore, and if I'm not talking revolving credit accounts I can be found running the trails of Wellington.
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