Borrowers rush to break loan terms for cheaper rates, but is it a good idea?

Wednesday, 20 May 2020

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Increasing numbers of New Zealanders are trying to break their fixed-term home loans, looking for a better rate, mortgage brokers say, but it rarely makes sense to do so.

Interest rates have fallen again over the past month as the country responds to the impact of Covid-19 on the economy, and the Reserve Bank has suggested that there could still be room for them to drop further.

Some commentators expect the official cash rate could turn negative, which could take fixed home loan rates below 2 per cent.

Two years ago, borrowers were being offered two-year rates of 5.05 per cent, Reserve Bank statistics show. Now, those rates have fallen as low as 2.99 per cent. ANZ on Wednesday revealed its new one-year rate of 2.79 per cent.

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Kiwibank spokeswoman Kara Tait said the bank had experienced a 60 per cent increase in inquiries about breaking fixed terms since it rolled out its 2.99 per cent special. ANZ also reported a lift.

Mortgage adviser Glen McLeod, of Edge Mortgages, said “every other call” he received was from someone wondering whether they could break the home loan term they were on to take a lower rate.

But he said it barely ever made sense.

Home loan rates have dropped further over the past month, leaving some fixed-term borrowers frustrated.

Whenever someone breaks a fixed-term loan, the bank usually applies a break fee to recover its costs.

How much the fee is depends on how long you have left of the fixed term and what the bank could lend the money to a new borrower for, as well as the wholesale cost of bank funding. That means that you often end up paying the same amount in a fee as you could save on a lower rate.

In one case McLeod dealt with, a client was quoted $1400 to break a loan but would only save $1200 in interest costs. Another was quoted $4000 to break, with savings of $3000.

Bruce Patten said many people inquired about breaking their fixed term but few went through with it.

A third client was quoted $7000 to break a longer-term loan, which would have resulted in savings of $9000.

But because he did not have the cash and would have had to borrow the $7000 to pay the fee, it still did not make sense, McLeod said.

Another adviser, Bruce Patten, said he was also dealing with a lot of inquiries but barely any had pursued the idea once they worked out how much they would have to pay to do so.

Many people were inquiring about breaking loans that were due to finish this year, anyway, and at rates only marginally above what was advertised. “I’m getting inquiries from people on a 3.39 per cent rate that’s due to refix in December. What’s the point? There’s no benefit in breaking it now, rates will probably be lower in December.”

He said break fees had become noticeably higher compared to the savings people could achieve in recent months. “They might have previously been close to breaking even but now it’s way out. They might recover 50 per cent of what it costs to break. If they go floating they are also paying a premium of 1.5 per cent or more to sit on floating.”

He said many would have had to put their break fees on to their loans, as McLeod’s client would have, which then meant they would pay interest on the money for years. “That’s hard pill to swallow.

“A lot say ‘why won’t the bank waive it?’ I say how would you feel if the bank came to you with a term deposit and said ‘the rates have gone down, we want to pay you less’. They don’t do that.”

Banking expert Claire Matthews, of Massey University, said it usually needed to be a substantial saving in interest rate to make breaking worthwhile, or the loan would have to be near the end of a fixed term.

'It is quite difficult to do this calculation in general terms, because it really does depend on the specific details of what the current fixed rate is, what the new fixed rate would be, the remaining term on the current fixed rate, and the break cost,' she said.

McLeod said people could only make the best decisions about their loans based on the rates available to them at the time they fixed.

“When the decision was made, that rate was good and sometime you just need to roll with the punches. Sometimes you lock in and rates skyrocket, then you’re laughing.”

ASB chief economist Nick Tuffley said it seemed that the only way interest rates would move in the short-term would be further down, but he did not expect a dramatic drop.