Rupert Gough: Would you fix your mortgage rate for 30 years?

COMMENT: With New Zealand mortgage rates on the rise, some homeowners may be asking themselves why Kiwi banks don't offer fixed mortgage rates for 30 years, like in the US.

In New Zealand, the maximum term you can typically fix your mortgage rate for is five years. There have certainly been headline-grabbing exceptions in the past, but most of these have come with hindsight-regret as interest rates continued lower.

Fixed-rate terms in New Zealand aren’t tied to the term of the mortgage. That is to say, you can have a one-year fixed rate with a 30 year mortgage term. The US is quite different. If you fix your mortgage rate for 15 years, the principal payments will also be over 15 years. The same with the 30-year fixed rate being paid over 30 years.

It would be an interesting survey to find out what interest rate a Kiwi homeowner - currently able to lock in a one-year rate of around 3.2% - would pay to lock in a rate for 30 years. The decision point would largely centre on how much “premium” they’d be willing to pay in the short term to be better off, on average, over the long term. In other words, they might be willing to pay 6.2% (a premium of 3% over today's cheapest rate), comfortable in the knowledge that, over the life of their 30-year mortgage, the average amount they would pay would be less than 6.2%.

My personal opinion is that anyone who is forecasting further than two years out is purely guessing. So much can change in two years, let alone 30 years. Consider a new homeowner in 1991 trying to forecast the next 30 years. Anyone who guessed record lows in interest rates would have been laughed out of town.

Break costs are certainly something to consider. In New Zealand, a very rough formula for break costs is the difference between the current interest rate and the rate that is locked. In other words, if you are locked at 4% with a year left and the new rate is 3%, the break cost is likely to be near 1% (it’s not always true but a good place to start for an estimate). With two years left, the break cost of the example above could be around 2%. You can see the problem of breaking a 30-year fixed rate. In the US, maximum break fees (referred to as a prepayment penalty) generally start at 2% and reduce from there. Obviously the break cost calculations in New Zealand would need to change significantly before anyone would risk a 30-year fixed rate.

So how much would Kiwis pay for a 30-year rate (assuming break fees are capped)?

Currently, banks assess mortgage affordability (called the servicing rate) at around 6%. It would make sense for the 30-year rate to be the servicing rate, after all that’s exactly what the homeowner will pay for the entire mortgage. And, while 6% feels like a big premium to pay, it is historically much lower than the average over the past 30 years.

In the meantime, it is useful for anyone with an upcoming refix to think about the term they lock in for in the same way as they might with a 30-year term decision. That is, if they are deciding between a one-year (cheapest) rate or, say, a three-year rate, the thought process should be: will the average of three one-year rates be cheaper than the three-year fixed rate? There’s a bit of crystal ball gazing involved but three years is easier than 30!

- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.