MORTGAGE DILEMMA

To fix or float? How to decide

IF PEOPLE discussing whether to fix or float their mortgage makes you feel dumb, you are not alone.

Mortgage experts say they see masses of borrowers chasing the lowest rates available on any particular day with little knowledge, foresight or strategy.

But drill down, and it is clear there are also borrowers seeking to smooth the ups and downs of mortgage interest costs (see chart above) with a mix of fixed and floating rates, as well as opportunists willing to take risks and move aggressively to lock in attractive rates when they see an opportunity to ‘‘beat the banks’’.

Your strategy becomes more important when rates are on the rise as they are currently.

March, April, June, and July all saw the Reserve Bank lift the official cash rate, and against that backdrop a great lurch from floating rate loans to fixed rate loans has happened.

Reserve Bank figures show households had floating rate loans on banks’ balance sheets totalling $91.2 billion at the end of May last year, compared to $93.4b in fixed rate loans.

But by the end of March this year, there was just $64.3b in floating loans compared to $129.7b in fixed.

The shift actually began around May 2012, but its momentum has grown this year.

Mortgage experts doubt it’s been the result of careful thought and planning.

Former banker John Bolton, founder of Squirrel Mortgages, says: ‘‘The vast majority of Kiwis don’t fix for certainty, they fix because that is the lowest rate on the market.’’

The average floating loan rate rose above the average two-year fixed rate in May last year when the proportion of floating to fixed rate loans by value was roughly 50/50.

At the end of May this year, there was just under 50 cents in floating loans for every dollar in fixed.

But the numbers indicate that’s not the whole story.

A decent chunk of the floating money was fixed for periods of two or more years, indicating homeowners were willing to pay more now in the expectation of further mortgage rate rises.

The timing of borrowers’ interest rate calls varies in

‘The vast majority of Kiwis don’t fix for certainty, they fix because that is the lowest rate on the market.’

effectiveness.

For example, in April last year some borrower’s fixed their mortgages when the average fiveyear rate available was 6.29 per cent.

At the end of May this year, others followed suit when the average five-year rate was around 7.1 per cent.

Will fixing for a longer term turn out to be the right call?

Time will tell, but history shows not all long-term fixes have worked out well, and are as subject to the same human biases, and fear and greed, that effect sharemarket investors.

Bolton points to people who fixed on five-year fixed rate mortgages in 2006 and early 2007. With the floating rate at over 10 per cent, five-year rates of just under 9 per cent seemed attractive.

Then the Global Financial Crisis struck, and interest rates crashed, leaving the five-year fixers rueing their decisions. It prompted many to seek to ‘‘break’’ their loans only to discover there would be big fees for doing so.

It was a scenario that indicated poor interest rate forecasting skills in many households, and the risk of trying to forecast rates over many years.

However, mortgage broker Karen Tatterson from Loan Market says even the experts, whose views are widely publicised, don’t have a great track record either when it comes to forecasting rates. One bank economist told her recently that economists were wrong 80 per cent of the time, she says.

Bolton identifies another human bias that seems to play a role in the decision of whether to float or fix.

Most people, he believes, will only make that call if the interest rate they are opting for is within half a per cent of the lowest rate.

Derek Bonnar from mortgage researcher Canstar says: ‘‘When floating rates are low it’s difficult for many people to fix at a higher rate. It’s natural to think: ‘Why should I pay 1 or 2 per cent more to fix when floating rates are this cheap?’ ’’

Sometimes other human factors play a role in fixed versus floating decisions, such as doing nothing because you don’t know what to do.

Bolton believes that a proportion of borrowers who ended up with floating rate loans in the buildup of floating rates that began in January 2011, did so simply because their fixed rate loan period ended and the loan defaulted to a floating rate.

People with no firm idea of what to do left their loans floating until the interest rate rises prompted them to action.

Given mortgage borrowers are trapped into long-term mortgage rate cycles, is it still possible to devise a lifetime strategy for deciding when to float and when to fix?

Brokers say strategies, which are often adopted depending on borrowers pyschological makeup and risk-tolerance, include: A a subset of people who try to outwit the market in search of low rates by making aggressive calls on forecasts of where interest rates are heading.

• Others base their fix and/or float decisions around limited household budgets and repayment plans.

• Some people recognise they won’t beat the market, but seek to smooth rate rises and falls by always having a mix of fixed periods, so that all of their loan does not come up for refixing at the same time.

• Some make the best fix and float calls they can, but focus on repaying their loans as fast as possible guided by the idea that it is not the rate a borrower repays, but the rate at which they repay that matters.

Based around trying to encourage people to repay loans faster, and hence slashing the interest they pay over the lifetime of a mortgage, Bolton has come up with the ‘‘Fixed for Life’’ concept.

Under this borrowers plan their mortgage repayments as though interest rates were 8 per cent, which is higher than the long-term average.

Not only will they make rapid headway in their loans, but they can stop sweating the rises and falls of interest rates.

And Bolton says history indicates they could do worse than chasing the best rate of the day each time a portion of their loan comes up to refix, as long as they stick to short-term fixed rate loans.

Margins are lowest for one- and two-year loans, where banks compete the most fiercely, and typically highest on floating rate loans to reflect the convenience and flexibility.