What is the difference between a fixed and floating mortgage?

What is the difference between a fixed and a floating mortgage?

A fixed rate is an interest rate the lender locks in for an agreed period. During that period the rate does not move, so your repayment stays the same no matter what happens to interest rates in the wider market. Fixed periods offered in New Zealand commonly run from six months to five years.

A floating rate, also called a variable rate, can be changed by the lender at any time. When it changes your repayment changes with it, so the amount leaving your account each fortnight or month is not locked in.

The trade is certainty against flexibility. A fixed rate gives you a predictable repayment but restricts how much extra you can pay off and charges a break cost if you exit early. A floating rate lets you make extra repayments freely and pass a lump sum straight onto the loan, but leaves your repayment exposed to every rate move.

Is the fixed period the same as the length of your mortgage?

No, and this is the single most common point of confusion for first-home buyers. The loan term is how long you have to repay the whole debt, commonly up to 30 years. The fixed period is only how long the interest rate is locked, usually a few years at most.

So a 30 year loan fixed for two years is one loan with 28 years still to run after the fixed period ends. Nothing about the loan finishes at the end of a fixed period. Only the rate arrangement does.

What happens when a fixed term ends?

You choose a new rate arrangement, which is called refixing. The lender contacts you before the fixed period expires and offers the fixed rates it has available at that moment, and you can take one of those or let the loan move to the floating rate.

The new rate is whatever the market is offering then, which may be higher or lower than the rate you have been paying. If it is materially higher, the repayment steps up on the day the new rate starts, and it is worth working out that number in advance rather than meeting it by surprise.

You are not obliged to stay with the same lender at that point. Refixing is also the moment when moving your loan elsewhere is cheapest, because there is no break cost on a loan that has reached the end of its fixed period. Refinancing has its own costs and paperwork, and it is a decision to work through with your lender or a licensed mortgage adviser.

What is a break cost or break fee?

A break cost is what a lender charges when you end a fixed rate before the agreed period is up. It applies when you sell the property, refinance to another lender, repay a large lump sum, or switch to a different rate part way through a fixed term.

It exists because the lender priced your fixed rate against funding it arranged for that period. Broadly, the charge reflects the difference between your fixed rate and what the lender can now get for the remaining time, so a break cost can be substantial if wholesale rates have fallen since you fixed and close to nothing if they have risen. The calculation is set out in your loan documents and differs between lenders.

You can ask your lender for the exact break cost figure before committing to anything, and it is reasonable to ask for it in writing. Fixed loans usually also allow some extra repayment each year without triggering a break cost, commonly in the range of 5 to 20 percent, and the allowance is specific to your lender and your contract.

Can you split a mortgage between fixed and floating?

Yes. Lenders will usually let you divide one loan into portions and set the rate arrangement separately on each, for example fixing most of it and leaving a smaller portion floating.

Splitting can also be done across several fixed portions with different end dates, so that not all of the loan refixes on the same day. That spreads the point at which your repayment resets rather than putting the whole loan onto one new rate at once.

A split does not remove either risk, it divides them. The fixed portion still carries break costs and repayment limits, and the floating portion still moves when rates move. How a loan should be split, if at all, depends on your income, your plans and your tolerance for a changing repayment, which is a conversation for a licensed mortgage adviser or your lender.

Is it better to fix or float?

Neither is better as a general rule, and anyone who tells you otherwise is guessing about future interest rates. What each option does is well defined; which one suits a particular household is not a question general information can answer.

Fixing removes uncertainty from your budget for the length of the fixed period and protects you from rate rises during it. In exchange you give up the benefit of any falls during that period, you accept limits on extra repayments, and you take on a break cost if your circumstances change.

Floating keeps you flexible and passes on any falls immediately, and it suits people who expect to repay a lump sum or sell in the near future. In exchange your repayment can rise at short notice, and floating rates in New Zealand have historically sat above the fixed rates on offer at the same time.

Paagaa gives general information and does not recommend a rate structure, a term or a lender. A licensed mortgage adviser can give you regulated advice based on your actual numbers, and free financial mentors are available if paying for advice is not realistic right now.

What is worth checking before you fix or refix?

There is a short list of questions any lender or adviser should be able to answer plainly, whatever you decide. Getting the answers in writing costs nothing and makes the comparison between offers a real one.

• How long is the fixed period, and what date does it end?
• What would the repayment be if the rate at the end of the period were higher than it is now?
• How much extra can be repaid each year without triggering a break cost?
• How is a break cost calculated, and can you have the current figure in writing?
• If a cash contribution is being offered, how long must you stay before it has to be repaid?
• Does the structure still allow the offset or revolving credit arrangement you want?