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With interest rates falling rapidly, homeowners can save tens of thousands by restructuring or refinancing their mortgages - but they face a new headache in early repayment fees.
Principal of Squirrel Financial Solutions John Bolton says his mortgage brokerage has saved new clients more than $1 million by changing their mortgages - including $128,000 for one customer on a seven-year fixed rate.
Another client will save $20,000 in interest over the next four years on a $300,000 loan. The average saving has been between $2000 and $4000 a year.
He calculates how much borrowers can save as the change in interest they pay over the remaining fixed term of the mortgage minus the penalty fee charged upfront to break it.
The penalty is called a "mark-to-market" fee and is hidden in the small print of all bank mortgage documents. It 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.
If you took a five-year fixed rate in the past two years, or your mortgage is with ASB, BNZ, the National Bank or Sovereign, you will likely save significant interest by breaking the term and taking a new rate, Bolton says.
This is because these banks calculate the break fee off how far customer interest rates have fallen since the mortgage was fixed, which is not as far as wholesale rates have as a result of the credit crisis.
For those banking with ANZ, Westpac or Kiwibank, the benefit of breaking your mortgage is likely to be much less, because these banks calculate the break fee off wholesale interest rates.
"The penalty fee will be a lot higher and you are less likely to save on interest," Bolton says.
But it may be worthwhile for those needing to improve their cashflow by dropping to a lower repayment rate.
For people struggling, lowered mortgage rates are a chance to repackage their debts on to their home loan. One client was paying 9.7 per cent interest on her mortgage and had $50,000 of consumer finance debt, on which the interest was 20 per cent.
She was facing a mortgagee sale, so the best option was to break the loan, capitalise the penalty on to the mortgage and partially consolidate some consumer debt on to it as well. This improved her monthly cash flow by $1000.
Borrowers who have taken a longer-term fixed rate and need to sell their property in the next few years will be confronted with a repayment fee of several thousand dollars.
"I'm aware of a number of sellers now getting caught out. The worst faced a penalty fee of $28,000," Bolton says.
Falling mortgage rates come at a time when central banks around the world have been slashing interest rates dramatically in response to the economic slump. And the Reserve Bank has been busy too, cutting the official cash rate by 3.25 per cent since July, including a 1.5 per cent cut in early December.
The OCR is now 5 per cent, its lowest level since 2003 and a far cry from the heady days of 8.25 per cent in July.
Westpac economist Doug Steel predicts it will reach a trough of around 4 per cent by mid next year. "The main message is we expect the OCR to fall significantly further," Steel says.
So why are the banks yet to pass on interest rate cuts matching the OCR? Claire Mathews, senior lecturer at Massey University's Centre for Banking Studies, says the OCR is the rate at which banks lend to each other - but they source the funds they lend to customers from funds on deposit and from wholesale markets, particularly from overseas, which are priced differently.
Another reason it takes time for banks to feed through lower borrowing rates to customers is that banks have a reasonable amount of money on term deposit and are stuck with whatever interest rate they have agreed to pay on term deposits, usually of 90 days to six months, until they mature.
"But banks should be reducing their rates more quickly," Mathews says.
Mortgage rates are forecast to bottom out around June. Short-term rates could fall to 5.5 per cent, with longer term rates falling to around 6-6.5 per cent, Bolton predicts.
The best option for borrowers is to take a six-month fixed rate now at 6.5-6.9 per cent. "In six months you can then look to split your mortgage into multiple fixed rates and spread them over three- to five-year fixed terms." A combination of fixed terms should let borrowers lower their average overall mortgage rate to around 6 per cent and build long-term rate protection.
Bolton says long-term rates are "stubbornly high" at present, but competition should bring them down as customer demand moves to longer-term rates. "Anything below 6.5 per cent for five years is great value," Bolton says.
About 30-40 per cent of homeowners make the wrong choice because they look at the lowest rate. Long-term rates are lower than short-term rates because the market expects rates to fall. This is the wrong time to take a longer-term rate. When interest rates are low and long-term rates are higher, this is because rates are expected to increase. This is the wrong time to take short-term rates, especially a two-year fixed rate.
