Mortgage rates keep falling: when is changing your contract most worthwhile? Let’s do the sums

Mortgage rates are trending downwards

The Reserve Bank of New Zealand’s official cash rate currently stands at 0.25%. Some commentators predict that it could fall further, even turning negative, potentially pushing fixed mortgage rates below 2%.

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Reserve Bank statistics show that the two-year fixed mortgage rate offered to borrowers two years ago was 5.05%. It has now fallen to 2.99%. ANZ went further this Thursday, cutting its one-year fixed home loan rate to a record low of 2.79%, and said it would subsequently reduce most of its other main mortgage rates.

Kiwibank spokesperson Kara Tait said that since the bank introduced its special rate of 2.99%, enquiries about breaking existing fixed-rate mortgages to switch to the new rate had increased by 60%. ANZ also reported a similar increase.

So, is asking your bank to break your existing fixed-rate mortgage and switch to a new rate the best option? We need to consider the following questions:

Will the savings cover the break fee?

After adjusting their rates, banks will usually agree to let customers break their existing fixed-rate mortgages and switch to a lower rate. However, borrowers must also pay the bank a break fee. 

Glen McLeod, a mortgage adviser at Edge Mortgages, said he had received numerous calls seeking advice on whether to break an existing fixed-rate home loan contract to obtain a lower rate. But he believes there is little practical benefit in doing so. “When you want to break a fixed-rate loan contract with a bank, the bank will usually charge a break fee to cover its losses. The amount depends on how much of the fixed term remains, the return the bank can earn by lending the money again, and its overall funding costs. This means that seeking a lower rate may ultimately make little difference to the total amount you pay.”

In some cases McLeod had handled, one customer would have had to pay a break fee of NZ$1400 to save NZ$1200 in interest; another faced a break fee of NZ$4000 but would gain only NZ$3000 from the lower rate. Another customer could break their existing contract for NZ$7000 and save NZ$9000 by switching to a lower-rate contract. However, because that customer did not have enough cash, they would have to borrow another NZ$7000 to pay the break fee. McLeod therefore still considered it not worthwhile.

Another mortgage adviser, Bruce Patten, backed McLeod’s assessment. He said he was also handling many such enquiries, but once customers understood how much they would have to pay in break fees, almost none wanted to proceed.

Could rates fall further after you change your contract?

ASB chief economist Nick Tuffley believes mortgage rates are likely to fall further in the short term, although he does not expect a substantial decline.

Many people wavering over the attraction of lower rates actually have fixed-rate loans that expire this year. Their rates are only slightly higher than those currently advertised by banks. “Some customers who have contacted me are currently paying 3.39%, with contracts expiring in December. What is the point of breaking them now? There is no benefit, and rates may be even lower by December,” Patten said.

Patten believes that, in the current circumstances, break fees are substantially higher than the savings people might make under a new loan contract. “Previously, the break fee might have been roughly balanced by the savings from a lower rate, but things are different now. The savings may cover only 50% of the cost of breaking the existing mortgage contract. If you choose a floating rate, you may also need to pay an additional lending risk premium of 1.5% or more to obtain approval.”

Moreover, many people may have to add the break fee directly to their loan, like McLeod’s third customer, meaning they will pay interest on that amount for many years. “Many people ask why banks cannot waive break fees. My response is: how would you feel if, when paying out your term deposit, the bank said, ‘Interest rates have fallen, so we would like to pay you less’? That is why banks cannot do that.” 

McLeod also wants to remind customers that people can only make the best borrowing decision based on the rates available from banks when they sign. They cannot control interest rate movements during the subsequent fixed term. That can lead to frustrating situations like the present one, but rates could also soar and leave you with little to smile about. It is best to take it in your stride.

Should you switch banks to change your rate?

If you have decided to break your contract, how should you proceed?

Some people may choose to switch lenders to obtain a lower rate or compensation for their break fee. This may not be wise at present unless you have secured confirmation from the new bank beforehand, as banks may be more cautious about lending to new customers during these exceptional times. The suggestion is to compare rates across banks, then negotiate with your existing bank to see whether you can secure the most satisfactory rate under a new contract.

Finally, to sum up the article’s main points in the words of Massey University banking expert Claire Matthews:

Whether breaking an existing fixed-rate mortgage is worthwhile depends on two considerations:

• Whether switching to a lower rate will deliver real savings.
• Whether the existing contract is close to expiry.

“Generally, it is difficult to calculate which option is more beneficial, because it really depends on factors such as the current fixed rate, the new fixed rate, the remaining fixed term and the break fee,” Matthews said.