Floating rates on a high

Falling interest rates means more New Zealand home owners are turning to floating rates. Photo / NZ Herald

Lower interest rates are prompting Kiwis to abandon their preference for fixed over floating-rate home loan terms.

Bruce Thompson, spokesman for Kiwibank - New Zealand's biggest mortgage lender in the December quarter - says that, in January last year, 80-85 per cent of all loans were on fixed rates.

By January this year, a dramatic reversal had occurred - 80-85 per cent of borrowers chose floating rates. Those who went for a fixed rate chose short terms.

Now, he says the mix is 50:50, with those borrowers choosing to fix their rate going for a variety of short, medium and long terms.

New Zealand has conventionally been a nation of fixers. Until recently, more than 85 per cent of mortgages have been on fixed-rate, long-term deals. But that figure has dropped to 76 per cent and analysts say it could go even lower.

BNZ chief economist Tony Alexander says: "I would expect to see that heading back to 70 per cent over the next few months."

ASB chief economist Nick Tuffley agrees there is evidence more New Zealanders are choosing floating or very short-term deals, although it could take some time for the trend to take hold.

"People will have to start weighing up the value of certainty against the benefit of the 'here and now' of extraordinarily low interest rates."

It's too early to say whether this trend is a genuine shift away from New Zealanders' traditional love affair with fixed rates. Even in the current volatility, the situation contrasts starkly with that in Australia, where only around 20 per cent of borrowers are on fixed rates.

Rather than reflecting a permanent realignment with the Australian preference, Kiwi borrowers on variable rates may be waiting for the optimum point to switch back to fixed, expecting further falls.

Kiwibank's Thompson says, "The number of people who went on our variable rate did so in a 'watch and wait' mode".

Alexander says: "With floating rates falling away sharply, people are wanting to get themselves fixed at a low interest rate." Their timing may be right, with further falls expected on the back of another likely cut to the official cash rate this month, which economists are picking will drop it another 50 basis points as it heads to an eventual low of 2 per cent.

British-born broker Jeff Royle from the Specialist Lender says the popularity of fixed rates in New Zealand is unique. "I've never come across a country so besotted with fixed rates."

Aussie home buyers are far more likely to opt for "tracker" mortgages, he says. "Interest is charged daily. There are no penalties for over-payment, so you can reduce the term and the amount of interest you pay significantly." But Royle says with those kinds of mortgages, you have to be very disciplined. "I don't think New Zealanders are. You can get into all sorts of trouble."

Borrowers have also run into trouble in large numbers when they've sought to break their fixed-rate contracts early to take advantage of the lower rates. But this isn't the only reason a borrower may seek to break a fixed-rate loan term early.

Personal circumstances can change in a multitude of ways, from a relationship break-up to a job loss, meaning borrowers need to accurately factor potential break fees into the equation when deciding whether to fix or float.

A break fee is calculated on the size of the mortgage, its remaining fixed term when it is repaid and how far interest rates - either customer or wholesale rates - have fallen since it was fixed.

Kiwibank, Westpac and the ANZ calculate break fees using wholesale rates and they are more expensive in a lower retail interest rate environment. As a result these banks have experienced "the worst of the publicity" over break fees, Thompson says.

"That's something we simply have to take on the chin. If someone breaks a contract, that is what the cost is to Kiwibank. We pass that on."

David Tripe from Massey University's Centre for Banking Studies believes banks should use wholesale rates to make their calculations, as they are a truer reflection of their costs. For banks to use the retail rate could be seen as an "act of charity".

Broker Kim Lyons of Be Mortgage Free says the real issue is that the break fee calculations are so complex that not only are they beyond the comprehension of most borrowers, but there is scope for banks to make errors as well.

His business partner, Steve McGowan, says: "Banks have made some big mistakes - how many get missed and get paid and fall under the radar?" He says the sector should have a "standard formula" so customers understand the banks' machinations - a view shared by the Productive Economy Council, which has called for government intervention.

Consumer website homeloanexperts.com reports: "The banks don't tell you what their current costs of funds are, so it is difficult to be sure that they are doing the break fees calculation correctly.

"We have received reports that some banks are purposely manipulating the break fees charged by using the difference between the rate you have and their current wholesale rate, rather than the wholesale rate when your loan was advanced and the current wholesale rate."

The website advises customers who suspect they are being "ripped off" to make a formal complaint and ask their bank to explain their calculations.

Break fee shock

When English couple Paul and Sarah Fry took out a $200,000 mortgage to buy a home in Orewa two years ago, they opted for a five-year fixed rate deal of 7.9 per cent from Kiwibank.

Since they had no thoughts of upping sticks at that time, the issue of break fees was far from their minds. But, as with most families, things changed - and it now seems they may have been better off with the flexibility of a floating rate loan.

They received news their first grandchild was on the way back in Britain, then their youngest daughter in New Zealand chose to move back to the UK. They decided to sell their property, even though they knew they'd be stung with a hefty break fee.

"When we broke the deal the retail interest rate on offer was 5.9 per cent," says Paul. "We expected to pay around $11,000 in break fees and were unhappy, but prepared to swallow that."

But the couple was shocked to discover the total cost of breaking their contract was to be almost twice as much as they estimated - $20,000. The bank said it used the wholesale rate (at which it borrowed the money) rather than the retail rate.

"In the small print was a clause that said the wholesale rate might be applied," says Fry.

"But at no point was a wholesale rate mentioned when the deal was offered. Had we known the scale of the likely penalties, it's possible we might have looked elsewhere. A $20,000 break fee on a loan worth $179,000 at break is akin to a loan shark rate."

Fry says the experience tainted the couple's otherwise happy four-year stay in New Zealand, and left a hole in their finances.

Kiwibank spokesman Bruce Thompson says the issues around breaking contracts are clearly outlined in the bank's documents. "We explain there is an interest rate break calculation. "The formula is disclosed in the terms of the contract. The real issue is, was the couple misled? It doesn't seem like they were. It's only because their circumstances changed. We have no control over that."