To Break or Not to Break? That is the Question

7 August 2015

We have seen quite an increase lately, in enquiries from people who have been watching the downward movements of Interest rates and wondering whether now would be a good time to restructure or refinance their home loans. A lot of this interest is generated by clever media coverage and bank advertising. But as with most adverts, you don’t get the whole story, merely a teaser to appeal to the most basic human desires, i.e. It’s going to cost you less, it’s going to make your life better or make you irresistible to the opposite sex! But having created the interest in the lower cost home loan rates, lets focus on those movements and what’s involved if you do want to change your loan structure.

In order to stimulate the global economy, most central banks the world over, control spending by the raising and lowering of Official Cash rates (OCR). As the Reserve Bank noted in a recent statement, “Global economic growth remains moderate, with only a gradual pickup in activity forecast. Recent developments in China and Europe led to heightened uncertainty and increased financial market volatility.” This volatility and a weakening of our own local economy has seen inflation drop to the bottom of the Reserve Bank’s target range, prompting the reduction of the Official Cash Rate at each of the last two reviews.

As mentioned in previous articles, the OCR doesn’t directly affect the pricing of fixed rates, so there are a whole range of other factors driving the current downward movement of the costs to borrow. New Zealand differs from many world markets by having a large percentage of its home loans on fixed rather than floating rates. This is due to the fact that for several years it has been the cheaper and more stable option. Yet, the forecast from most analysts is that there will be further drops in interest rates later this year, especially for floating rate loans and shorter fixed rate terms which are more directly linked to the OCR than the longer term options.

All good for those on floating rates, but what happens if you are tied to a fixed rate and seeing the rates drop makes you want to look at the option of changing. The first thing to bear in mind is that there will be costs to change. Dependant on which lender you have your home loan with will determine what sort of charges and break costs are involved. Whether they call them break costs, early repayment fees or early exit fees, they all amount to the same thing. A fee charged when you “break” your fixed rate loan. 

The fees are charged to cover the lenders costs. When the bank secures the funds to lend to you the borrower, they pay a wholesale interest rate on the day the funds are advanced. If those funds are repaid early the bank will have to cover the costs of the funds as they were borrowed over a specified length of time e.g. a 2 year fixed rate. If the interest rate has increased since the loan was taken out then the bank will be able to offset those costs and consequently the only charge will be the breaking fee. However, if the rates have come down, as is the case at the moment, there will be additional costs to exit the loan.

How this is priced varies from day to day and from lender to lender, however a good rule of thumb is the remaining time left on the fixed rate period multiplied by the difference in the cost of funds. This can end up being a significant cost and even more so if your loan is with one of the non bank lenders who will also charge deferred establishment fees amounting to around an extra 4% of the loan balance. It is vitally important that you should therefore contact your mortgage adviser in order to discuss the cost effectiveness of making such changes. There is no advantage if the costs to break your existing loan end up costing more than the savings to be made from the lower interest rate offered.

In some situations, these expenses in breaking fees can be justified by the savings in repayments or tax advantages to be gained in restructuring under a new loan structure, but it is imperative to discuss your requirements and reasons with your mortgage adviser and accountant before going ahead with breaking that loan.

 

Published In Whakatane Beacon

This post was written by

John White - who has written 90 posts

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