Claire Matthews: Ten years is a long time to predict rates

Financial advisers generally recommend repaying your home loan as quickly as possible because the quicker you do so, the less interest you pay. Photo / Warren Buckland

TSB’s fixed interest offer looks attractive but it’s locked in for a decade

TSB Bank's new 10-year fixed rate home loan has captured the imagination of homebuyers, along with plenty of headlines, since it was launched last week. At 5.89 per cent per annum, it is certainly an attractive rate - well below the current "standard" floating rate of 6.5 to 6.75 per cent.

But it would be a mistake to focus solely on how attractive that rate looks at this particular point in time.

What hasn't been widely discussed is the locking-in effect of a 10-year fixed rate on a home loan. TSB has made it clear that you can transfer the loan, and the fixed rate, to another property, so at least you can move house if you want to.

On the other hand, changing banks will not be so easy during the term of the fixed rate because the other thing TSB has made clear is that "early repayment interest" may be incurred on the early repayment of the loan. On a 10-year fixed rate, that charge could be considerable, particularly in the early years of the loan.

TSB, like the other banks, wants to retain customers. There is a cost to finding new customers, assessing their loan applications and opening their accounts. Customers who remain with the bank will usually become more profitable as time goes by. Consider, also, that when a customer repays a loan, the bank needs to find someone else to lend that money to. In the meantime the money is not generating any income for them. So, this new 10-year fixed rate enhances home loan customer retention for TSB - at the cost of flexibility for the customer.

Any customer who becomes unhappy with their relationship with TSB (which could happen, despite their excellent customer service reputation) will have to maintain that relationship until the expiry of the 10-year fixed rate. Imagine how frustrating that could turn out to be.

Financial advisers generally recommend repaying your home loan as quickly as possible because the quicker you do so, the less interest you pay. A long fixed-rate term works against this by restricting how much you can repay. While some additional repayments are possible with TSB's 10-year fixed rate product, early repayment interest will be incurred on payments in excess of the annual limits.

Ten years is a very long time when it comes to crystal ball gazing. While I agree that 5.89 per cent looks like an attractive interest rate in the current environment, there is no guarantee that it will continue to do so in the coming years.

At present, there is an expectation that the OCR will remain at its current level for an extended period before starting to rise. But in its latest economic overview, Westpac suggests there is a possibility of the Reserve Bank cutting the OCR during 2015. If that happens, how attractive will that 10-year rate look?

Some commentators have compared TSB's new product to the 30-year fixed rate loans available in the United States and other countries. However, in these countries there is no equivalent to the early repayment interest being charged by TSB, which means customers can simply repay their loan at any time. That has significant implications for banks in terms of financial management, which is why we are unlikely to see the same sort of products offered in New Zealand.

For some customers, this new rate from TSB will be just what they want. But it is important they understand exactly what they are committing to when they sign on the dotted line. We only have to look back to the late 1980s, when five-year fixed-rate terms were in their infancy, to see how it can all go wrong. Back then, interest rates were around 15 per cent and many National Bank customers locked in what looked like attractive rates for five years. When the Reserve Bank's efforts against inflation led interest rates to fall dramatically, there were plenty of customers who complained loudly and bitterly when they were faced with steep early repayment fees.

• Claire Matthews is a banking and financial planning expert from Massey University's Business School.