Don't Get Fixated With Your Mortgage

By David McEwen

Monday 15th January 2001

When I bought my first home more than a decade ago, I had to choose between a fixed or floating interest rate.

Smugly, I thought my background as an investment writer would allow me to choose wisely. After carefully reviewing all the options and considering likely political and economic scenarios, I concluded that New Zealand was heading for a bout of inflation that would push interest rates up. Therefore, I opted to fix my interest rate at the bargain-basement rate of 15.4%.

Within months, interest rates began sliding to single digits and I ended up buying my way out of what had become a financial liability.

If anything, interest rates have become more volatile and unpredictable since then.

Many people who have taken out fixed rate mortgages in recent years have regretted it. Some are panicked into taking out such mortgages because they believe warnings by economists and bankers that rates are on the rise. Such forecasts were made late last year but now banks are falling over themselves to cut their rates.

A decline in mortgage rates from 8.5% to 8%, such as we have seen this week, can shave more than $8,000 from the cost of a $100,000, 20- year floating rate mortgage. Therefore, borrowers should be cautious about locking themselves into any rate.

Another disadvantage in taking out a fixed rate mortgage is that most banks charge a penalty if the borrowing terms are changed. One of the reasons is that banks lock in their own funding for the same length of time (at a lower rate, naturally).

Banks go through phases of marketing fixed interest rate mortgages and the main message is that borrowers have the security of knowing what their payments are going to be in the future. This is true and is probably the only reason why someone should have such a mortgage.

I often wonder if banks promote fixed rate mortgages when they expect rates to decline, thus potentially locking customers in at more profitable rates. I have been assured that this is not the case. Fixed-rate promotions are more likely to be driven by the marketing department, who have no more idea about interest rate trends than anyone else.

Split loans, where a mortgage is divided into fixed and variable rate packages, are becoming more popular. This may appear to give the best of both worlds, but penalties on changing the fixed rate mortgage reduce their effectiveness.

Wouldn't it be nice if a bank offered split mortgages with no penalties, allowing customers to concentrate their payments on whichever loan carries the higher interest rate?

Finally, here's a hot tip from a banker about structuring a mortgage. Most people want to pay their mortgage off as soon as possible to save on the interest rate payments. This sensible but just because you intend paying off your mortgage in 10 years doesn't mean you should take out a 10 year mortgage.

There are advantages in taking out a longer-term mortgage, say 20 years, then increasing your payments to ensure you pay it off in half that time. One advantage is that, should an untoward event occur that means money is needed for another purpose, payments can be reduced without paying any penalties or restructuring fees.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

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