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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.
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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 story was first published in the Herald On Sunday on March 1, 2009
2 Comments
This is a sort of
This is a sort of sub-prime actually.
Agreed. And my concern is
Agreed. And my concern is that those who have gone on to floating, at teaser rates, may end up marooned if rates do not, as expected, fall. What could be worse than paying the break fee, only to find that a new, longer fixed term is little better than that which has just been broken.
what will happen to floating
what will happen to floating rates if we get a downgrade?
You should also point out
You should also point out that those of us who have broken it may actually have done there numbers properly and to see how long will it take to recoup the break cost and also benefit from the low intesrt rates, for e.g if your beak cost were 15K it may take 3yrs to pay that back but at the same time if you were to lock your mortgage for 3-5years and do not decrease your repayments i.e. the savings in interest as a result of a lower interest go back to pay the principle, then you can be better off. Atleast I am! So to publish an article without facts is not the way to go, is it?
Bernard How else would the
Bernard
How else would the poor lambs be able to pay additional tax to service the forthcoming wall of government debt issuance?
Term extension of one's liabilities is a well trodden treadmill advocated by the IMF to accommodate saving ourselves from ourselves.
No wonder Mr Key is thinking we should toughen up by cycling the length and breadth of the country.
And Fonterra looks BROKE, POWDER
And Fonterra looks BROKE,
POWDER MARKET COMMENTS: Demand for nonfat dry milk is slow; export interest is low; sales to the
CCC by California plants last week represented 60% of total sales. Internationally, Europe increased the amount
offered to subsidize exports of butter, cheese, and skim milk powder, and Fonterra continues to lease warehouse
space for storage. In the West, nfdm continues to sell for as little as $.77 per lb, 3 cents below support. There is
some hope for some powder to be used by cheese plants, but current milk and cheese prices are still far too low
for that to happen. There is now about 184 million lbs of product in CCC warehouses in California, but that is
sold and payment is on the way, while Fonterra is sitting on unsold product, is having to find places to put it,
is paying 7.5% interest on the stockpile, and is worried about how low Europe will go on prices. Is that a
clear enough picture for what lies ahead?
Europe has increased it Subsidy on milk and Fonterra is worried how far they will go! When dos that hit the media. When is Fonterras next announcement? They are going Down Down Down.
I agree with you Bernard
I agree with you Bernard in principle, but many people live pay cheque to pay cheque and are more concerned with up front costs than what they pay back over the term of a loan. Some people I know have recently taken "mortgage holidays" which is not something I would do as it gets capitalised, but I guess in their situation it temporarily relieves stress - especially one that lost their job - gives them time to try to get another one.
The majority of breaking fixed
The majority of breaking fixed to go floating happened in late November through December when break fees were not so high. Data on this is easily attainable for February and will show that very little refinance work happened in Feb compared with Dec.
Some people did a balance transfer and put the break fee on a credit card at 4.99% for 6 months and will quickly pay that off.
Many people have retained payments at the original level, they could afford to leave payments the same even though they could have had a big cashflow advantage floating at a new low rate and lower payments.
If you were on 8.8% with 2 years to go and in December broke the mortgage you would now be floating at 6.49% and will decide soon whether or not to fix for 3 or 5 years. You could fix today for 3 years at 5.99%
People who re-fixed in December to February for 6 months are the ones most likely to get caught out as rates may have headed back up by then but the average punter will have read the Sunday papers and believe interest rates still have a way to fall.
Here's a more common example
Here's a more common example using an interest only scenario:
$300,000 fixed at 8.8% with 2 years remaining as at Dec 2008
Was costing $507 per week or $26,400 per year
Break fee $8,000 early December
$308,000 today floating at 6.49% now costs $384 per week or $19,989 per year
$308,000 fixed at 5.99% for 3 years would cost $354 per week or $18,449 per year
So the end play is this:
Was costing in November $26,400 per year for $300,0000
Today can fix @ 5.99% or $18,449 per year for $308,000
Saving over the next 3 years is $23,853 and cost to break was $8,000
I too can do lots
I too can do lots of calculation in hindsight! I could even have picked when to sell my share portfolio! But what about here and now, Bank Manager?
That's what Bernard's atricle is about. What do YOU suggest, now, that is different to what Bernard is saying TODAY...
Break fees are calculated between
Break fees are calculated between the current interest rate or OCR rate (depends on the bank and what the debit is at.
I believe the ave fixed mortgage comes out late 2010 and is about 8.5%
IN HINDSIGHT
IF the break was taken mid last yr to a floating the fee would have been small
But now there is a big diff in points of calculation it is huge
If we where to break now and add to the mortgage we would save 6 weeks of repayments keeping the current repayments the same.
AND as Bernard mentions this ASSUMES (ass-u&me) that interest rates will stay low for the next 13 yrs....An assumption that is very unlikely and that there will be a min of 3 or maybe 4 fixed term negotiations in that time.
An increase on any one of those future negotiations of 2% above current rates and one pays considerably more and the loan period is extended, if the repayments are kept the same or slightly increased at some time
Bernard has done his home work and is 'right on the money'
One can bend the figures all you like, interest rates are not going to stay low for the full period of the loan.
Janet - Bernard has an
Janet - Bernard has an example of someone who has fixed at "8.95% with 4 years to run" - now come on - really how many people would be in that position right now?
The break to go floating wave of activity has been and gone. Stats on Reserve Bank website will show this when Feb data is available.
Acording to data freely available
Acording to data freely available at:
http://www.rbnz.govt.nz/statistics/monfin/rbssr/rbssrpartE/hrb_ssr_part_...
there were 343,000 floating mortgages in Feb 2008 vs 434,706 in Jan 2009
an increase of 91,706 - no wonder banks were snowed under in the last 3 months with that mountain of paper work.
That's a huge number of people making their own minds up as to the best course of action to take while waiting for rates to drop.
Option to consider is switching
Option to consider is switching to another bank. For every new home loan application banks contribute by some cash towards legal fee, or whatever is called. So, if you simply shift existing mortage to another bank, you might get at least $500. This is negotiable, and Kiwibank will contribute around $1000. This compensates for some of break-fee costs.
"This compensates for some of
"This compensates for some of break-fee costs."
Correct, but nowhere enough to make breaking cost effective, even with a loan well under $100,000
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