If it ain't broke, don't refix it

New Zealanders desperate for any form of immediate cost saving are making a huge mistake by choosing to break out of fixed mortgages and slapping the subsequently huge break fees back on to their mortgages.

It seems like a good idea in the short term, but borrowers will pay for this decision with a bigger debt and more interest payments over the life of the mortgage.

Banks report an increase in “capitalising” of break fees in the past three to four months. Some say as many as half of the 50,000 borrowers who have moved to variable rates from fixed rates may have capitalised the break fee on their mortgage.

A back-of-the-envelope calculation suggests that New Zealanders have added up to $500 million to the national mortgage debt over the past few months by doing this.

Most banks do not encourage it, but have little choice but to accept the decision, which is often suggested by brokers.

Some borrowers can’t do it because they don’t have enough equity in their homes to increase their loan-to-value ratio, particularly now that banks often limit these ratios to 80%. But many have some equity left, even though house prices are falling.

Here’s how it works. A mortgage borrower with, say, a $300,000 interest-only loan with four years to run at 8.95% is currently paying around $516 a week in interest payments.

The temptation is to break out of that loan to reduce the interest rate to 5.8 per cent and cut the weekly repayments to $334. The huge carrot of a $182-a-week reduction in interest costs is often too tempting.

The break fee on such a mortgage would be around $34,400, depending on the bank. Even with the break fee added to the mortgage, the lower interest rate means the weekly payments of around $373 a week deliver an apparent saving. But it is only apparent.

Over the life of a mortgage, the decision to capitalise the break fee will cost a total of $61,572 at current interest rates, including interest on the original break fee over a 20-year mortgage. This works out at an extra $60 a week. This also assumes interest rates don’t rise.

The big picture here is familiar. Borrowers desperate for a short-term consumption fix are borrowing for the long term and storing up more debt that will eventually have to be repaid and serviced.

This is the fundamental problem with the New Zealand economy, although we are not alone as this dilemma is dragging down most other developed consuming economies, too. We spent too much and now we have to repay the debt.

Adding to that debt will reduce the flexibility of borrowers if they lose their jobs in the next year or two. It directly reduces the equity buffer left in a house to rely on in the event of a real emergency.

The decision about breaking a fixed-rate mortgage and capitalising the break fee should be the catalyst for any borrower to have a fundamental rethink about their lifestyle, their debt levels and their appetite for risk when it comes to interest rate movements.

Before they break and capitalise, borrowers should ask what costs they can cut; how they can repay the debt earlier and what assets they can sell to repay the debt.

The answer should not be to borrow more and worry about paying it back later.

This article has kindly been republished courtesy of interest.co.nz.  To view this article and other news updates from interest.co.nz click here.

Posted: 1 Mar 2009

News articles

Browse articles
by date

September 2013

July 2013

June 2013

May 2013

December 2012

November 2012

September 2012

June 2012

April 2012

March 2012

February 2012

January 2012

December 2011

November 2011

October 2011

September 2011

August 2011

July 2011

June 2011

May 2011

April 2011

March 2011

February 2011

January 2011

December 2010

November 2010

October 2010

September 2010

August 2010

July 2010

June 2010

May 2010

April 2010

March 2010

February 2010

January 2010

December 2009

November 2009

October 2009

September 2009

August 2009

July 2009

June 2009

May 2009

April 2009

March 2009

February 2009

January 2009

December 2008

November 2008

October 2008

September 2008

May 2008

April 2008

March 2008

Please disregard these fields.


banner ad