A vested interest in paying less

You can slash $100,000 off the cost of your mortgage in one easy step, writes Susan Edmunds.

INTEREST rates have been the big talking point of the past 10 days. First, BNZ sparked this year’s spring mortgage rates war when it rolled out a record low one-year rate of 4.35 per cent.

Then ASB matched it. That was followed by the Reserve Bank’s announcement that, as predicted, it was cutting the Official Cash Rate to 2.75 per cent.

Banks quickly rolled out another round of rate cuts. Kiwibank was still firing mortgage war shots yesterday, lowering its floating rates by 0.25 per cent to 5.9 per cent and making smaller adjustments to its fixed rates.

This is all headline-grabbing and interesting for those who are taking out a new mortgage or have a loan due for a refix soon.

For most households, their home loan is the biggest regular chunk of money coming out of their bank account.

But borrowers do themselves a disservice if they spend too much time trying to time the market and lock in the absolutely lowest interest rates they can for the absolutely longest time, thinking that is the best way to cut the cost of their loan.

Economists’ crystal balls are notoriously cloudy when it comes to predicting the future track of interest rates.

This time last year, we were all told that rates were heading up and it was certainly the time to lock in mortgage rates.

Take it from one who followed this advice that those fixed-term rates over 6 per cent do not seem so attractive now with 12 months of hindsight.

At the beginning of the year, TSB made headlines with its 10-year rate of 5.89 per cent. Even Prime Minister John Key said he The more extra cash you can put toward your loan the faster the gain. thought it was a good thing.

Ten years in the market is a long time and who knows where rates will be in 2024.

By then, those TSB borrowers may be rejoicing in paying far less than the market rate. But right now, six months on, I wonder if they think they have such a good deal when ASB is offering 5.09 per cent for five years.

The lesson out of all of this is probably that rate picking should not be the biggest part of your home loan strategy.

It is nice to get a cheap rate – the difference between ASB’s floating rate at 6.5 per cent and its five-year special at 5.09 per cent is $186 a fortnight on a $500,000 loan being paid off over 20 years, a decent chunk of cash.

But a mortgage is a long-term commitment. Sometimes you will roll off a mortgage at just the right time to grab a great rate for a term that suits you. Other times you might not be so lucky.

It seems that borrowers who constantly chase the lowest rates on offer put themselves at risk.

Take that one-year 4.35 per cent rate and you will save some money over the next 12 months.

But where will rates be in September 2016? It is very hard to say. You could find they have already picked up again and you are stuck facing a much higher interest rate bill overall than if you had locked in a longer term now.

Borrowers should choose interest rate terms that suit them. If you are likely to need to move house within the next few years, don’t fix for a long term. If you are budget conscious or a new homeowner and need to know what your commitments are, a five-year (or longer) term may be ideal.

The argument to opt for a sixmonth rate, rather than keeping your loan floating, does seem sound – six-month rates are available below 5 per cent while floating is still above 6.

Some brokers argue that borrowers should break their loans up and fix the chunks for different terms so you have a bit of the loan rolling off every year to be refixed. This spreads risk effectively.

But when it comes to a mortgage, what really matters is the rate at which you pay it off. If you take that 5.09 per cent rate at ASB, your payments on a $500,000 loan will be a minimum $1533 a fortnight to pay the loan off in 20 years. Bump that up by $67 a fortnight and you will pay it off in 19 years, saving $23,342 at current interest rates.

Round it up to $2000 a fortnight – roughly what you would have paid when interest rates were at their last peak anyway – and you will pay off the loan in 14 years and save $109,988.

Put away your crystal balls and apply some strategic thinking to your loans. Look at ways to mitigate risk, such as spreading your loans over different terms, and look at what terms will suit your household.

But most importantly look at what extra cash you can put toward your loan. That is where the biggest gains are to be made.

And the best part is, the rate at which you do that is entirely up to you – not the Reserve Bank.