How To Choose The Right Interest Rate

A very distinct memory I have of my father that has seemed to sit with me is his explanation of why it was always “best” to choose the one year interest rates. Strangely, I’ve never taken the time to work out if this is true or not, I say strangely because interest rates are quite a big deal whether you’re a property investor, own your home or both. So today that’s what I’ve done with real numbers and the results are rather telling.

In 2015 the average house price in New Zealand according to realestate.co.nz was $556,931. This is the starting period of this comparison as the five years from 2015 reflects a much more “normal” period of interest rates than the following five years... so it seems reasonable to look at the numbers from this period. If you were to buy the “average” house in 2015 and using the banks money to borrow 80% on that purchase, you’d have a mortgage of just over $450k.

The choice every purchaser has to make at this point is how long to fix their interest rate for, you have choices from six months to five years, or leave it floating which is a topic for another day. Say you were to go to ANZ and ask for their standard mortgage rates (we’ve picked ANZ for the sole reason they are the largest bank in New Zealand) in January 2015 they would have offered you 6.59% p.a. to fix for five years or if you just wanted to fix for one year, a rate of 6.09%. The loan duration we’ve assumed is 30 years.

If you were to take the five year deal your payments (on a principal and interest loan) would be around $670 per week, totalling just shy of $175k over the five year period. But what if you’re confident interest rates will sit below the five year rate, and you fix for one year? Obviously your payments will initially be cheaper as the initial rate is half a percent less, but will they be cheaper over the whole five years and by enough to justify the “risk” of interest rate rises over this time?

Well, with the benefit of hindsight you’d have opted to re-fix each year. Interest rates sat fairly steady between 4.5% - 5.0% during this period. The borrower in this scenario pays nearly $30k less over the five year period and crucially, comes away with almost $10k more principal paid off from their loan than the borrower who locks in for the five year period. It’s the same story if you chose to go with the two year rates, this borrower would have paid a fair bit more than the annual re-fixer, but still over $20k less than the five year rate, and again their money has gone further, over $5k more principal repaid than the borrower on the five year rate.

So are we saying you should rush off to lock in the best one year rate right now? No, not even close. While it is clear in this scenario the one year rate would have served you better, we sadly still have no crystal ball to tell us if they will continue to be. Things to consider are your personal situation and your appetite for risk. Longer interest rate terms offer stability and for some people a very important sense of security in knowing what their payments are going to be for the next x number of years.

While historically shorter rates have given borrowers better outcomes, there is no guarantee they will continue to do so (past results are not an indication of future performance). For instance the numbers slightly reversed during Covid, if you bought the “average” house in 2020 and fixed for five years, you’d pay about $8k less to the bank over the five years, and pay off about $2k more principal than if you’d re-fixed every year. What we’re trying to say is there is no right answer without the benefit of hindsight, but understanding what is at stake helps you to assess what is right for you and your family in your situation. There are other factors to consider such longer term interest rates run the risk of large break fees if you are forced to sell at a less than ideal time. We’ve run this scenario to demonstrate what the real cost is so you understand how much of a risk either option is.

If you want to talk to us about any of the numbers in this article or would like a copy of our workings, please email and we will gladly assist.

Disclaimer: None of the content of this article are intended as financial advice and should not be interpreted as such or relied on solely when selecting an interest rate term. Historical mortgage rate data was taken from past versions of interest.co.nz using online tool Wayback Machine. All interest rates used in these calculations were the ANZ rate for the given year. We strongly recommend seeking independent expert advice when making a property purchase including but not limited to the services of a Chartered Accountant, Licensed Financial Adviser and a Lawyer.