Rocketing interest rates have put huge pressure on people with mortgages. There are things borrowers can do to reduce their payments, but remember, with banks there’s no such thing as a free lunch
If your home loan repayments have gone up 50 percent or more over the past year, or are about to do so, you are far from alone.
In August 2021, the average one-year fixed rate for owner-occupiers was 2.58 percent, according to bank research and ratings company Canstar. Now it’s more than double that.
And with nearly half of New Zealanders with a mortgage needing to refix their rates between October 2022 and September 2023, according to the Reserve Bank, that’s a lot of people facing a massive change in their household budget.
Take Daisy Warren and Zachary Brown, who told the Bay of Plenty Times repayments on their Tauranga do-up could go from $1200 a fortnight to $2000.
Or Aaron and Jessica Rubin, who are thinking about selling up rather than face repayments on their Nelson home going from $4000 a month to $6710 in March.
It brought tears to his eyes, Aaron told NZ Herald reporter Ben Leahy.
Canstar general manager Jose George says the company’s research team has been looking at options for homeowners. There are things people can do to reduce their interest payments, which don’t involve selling their home, though that is the last-ditch option. The trouble is, most are going to end up costing you more – possibly much more – long term.
Still, it’s worth checking out the options:
1) Hit up your bank about your low equity premium
This is probably the only exception to the short term gain = long term pain principle. It won’t help everyone, but could be a big help for a few, mostly first home buyers with low deposits, where their house has increased in value.
Low equity premiums (LEPs) are extra amounts charged by banks for customers who don’t have a 20 percent deposit. Banks argue low-deposit borrowers are at a greater risk of defaulting on their loans, and that Reserve Bank capital rules – introduced to make our banking system safer – make lending to people with low equity more costly.
Sometimes they are a one-off charge added to a mortgage, but often they come in the form of a higher interest rate – it can be an extra 1 percentage point – or more.
See Kiwibank’s fees chart here, for example. For a fixed rate mortgage up to two years, you pay 1 percentage point extra if you have less than a 20 percent deposit. Plus low equity first home buyers can end up being charged even more because they aren’t eligible for any special interest rates that might be offered to other customers.
Once a customer has got to 20 percent equity in their house, either because they have paid off enough of their loan, or because the value of their home has risen, or both, they no longer have to pay the low equity premium.
But in practice, banks often keep on charging the higher rate for months or even years after that magic day when the customer’s equity rises above 20 percent.
In fact, nothing changes until a customer turns up at the bank with a revaluation of their home (that they’ve paid for themselves) and a request for the bank to look into their equity situation.
By then they might have paid thousands of dollars in extra interest.
Getting your LEP reassessed isn’t too hard, as this page from Westpac’s website shows, but it requires the customer to do the work.
Newsroom has written about low equity premiums before – and not in a good way.
Bad things happen: The first home buyer tax
When we crunched the numbers in 2019, Newsroom found homeowners were collectively paying tens of millions of dollars too much each year because of the low equity premium issue.
Now interest rates are so much higher, customers will be losing even more.
George says if you think you might be in this situation, it’s definitely worth contacting your bank and asking them for a re-evaluation of the price of your home and your equity in it.
“If your level of equity has risen about the 20 percent threshold, you could receive a revised interest rate and enjoy substantially lower repayments.”
2) Extend mortgage term
There are other things homeowners can do if they are struggling with their mortgage payments, George says, but they come with fishhooks.
For example, extending the term of your mortgage will bring your payments down. If you’ve got 20 years left on the term of your loan, you could refinance it over 25 years, for example.
However, while it can save money in the short term, those extra five years can cost you a huge amount in extra interest repayments, George says. On a $500,000 loan, at the current average one-year fixed rate on Canstar’s database of 6.66 percent, the numbers look like this:
“While you would save $349 on your monthly repayments (a 9 percent reduction), those extra five years would result in paying $121,831 more in interest charges (30 percent extra), George says.
3) Switch to an interest-only home loan
It’s the same problem with switching your loan to be interest-only – short-term gain for long-term pain. As its name suggests, an interest-only home loan involves paying only the interest charges on the loan, and not paying down the principal loan amount.
Using Canstar’s example of a $500,000 loan at 6.66 percent, going interest only would involve cutting your monthly repayment to $2775. However, regardless of how long you paid that monthly amount, your debt would never reduce.
“This is why interest-only loans are usually favoured by property investors, and those aiming to make capital gains through property speculation,” George says.
4) Repayment holiday
For people facing severe financial stress trying to meet mortgage payments, banks will sometimes be prepared to look at a mortgage holiday – a break from making repayments on your mortgage for a few months.
Newsroom has written about that before too – and it’s definitely a last-ditch option.
Canstar crunched some numbers for us on this one too and they are shocking. If it was bad in 2020, with interest rates of 3.5 percent, it’s significantly worse when they are 6.83 percent
Someone with a 25-year, $750,000 loan, with 24 years left to pay, would end up paying almost $142,000 extra interest, or 17.4 percent more, just by taking a six-month payment holiday.
With 15 years left on the loan, that would be $58,400, or 7.2 percent more.
This compared with additional interest payments of $40,000 and $23,000 respectively when Newsroom did the same exercise in 2020 – still no picnic.
“It’s not something we recommend,” George says. “It was being pushed early on in the Covid pandemic as as an idea but it should be seen as a last resort for people who don’t have any options and need a bit of breathing space to get their finances under control.”
5) Talk to the bank
Way before you get to the point of a mortgage holiday, George says, the first step is to get in touch with your bank. Try to negotiate the rate, or if you have a floating rate, look to move some or all onto a short term fixed loan.
“No one wants to see home loans go bad.”
If you don’t get anywhere with your own bank, shop around. As an example, as Newsroom was writing this article, Heartland Bank was offering a one-year fixed rate of 5.89 percent, or a two-year fixed rate of 5.99 percent. At that time, Canstar’s refinancing home loans search was showing the cheapest other rate at about 6.5 percent and some as high as 7.65 percent.
The trouble is renegotiating your home loan is a hassle. The advent of open banking – which essentially hands ownership of your bank account data to you, rather than your bank – will make it easier to switch providers. But that is still in the future (albeit the nearer future after an announcement by Commerce and Consumer Affairs Minister David Clark in November).
Using a mortgage broker to compare options for you is another possibility, though as Consumer NZ’s Jessica Wilson wrote in an opinion piece for Stuff just before Christmas, the hidden commissions paid by banks to brokers to recommend their products potentially create a conflict of interest.
It’s not easy.
6) Reduce your revolving credit
Anyone with a mortgage in the present climate is going to end up paying more, George says. The trick is to get the interest rate down as much as possible on as much of your borrowing as possible.
Revolving lines of credit – a sort of flexible overdraft mortgage account, where you can put money in and take it out whenever you choose, up to your credit limit – are potentially a bad idea at the moment, because they are at the top end of the mortgage interest rate range.
For example, Kiwibank’s mortgage figures show rates rising from 6.5 percent per annum for a six-month fixed loan to 7.8 percent for a revolving mortgage.
If you can, consolidate some or all of the debt in your revolving account into a fixed loan, George says.
7) Offset deposits against your mortgage
An offset account is a transaction account that is linked to your home loan. The account’s balance (or a proportion of that balance) is offset daily against your home loan balance.
Say you had a mortgage of $500,000 and $40,000 in your offset account on a particular day. That day, you’d only pay interest on a loan of $460,000. If another day you had $20,000 or $60,000, you’d be charged on $480,000 or $440,000. When interest rates are high, the difference can add up.
The linked offset accounts don’t earn interest, but because you’ll be paying more interest on your mortgage than you are earning on deposits in the bank, you should be saving overall.
Of course, if you have spare cash sitting permanently in an account accruing less interest than you’re currently paying on your mortgage, it’s likely best to use it to reduce your mortgage debt, George says.
Some banks will allow you to make extra annual lump-sum repayments off your mortgage as long as they are no more than 5 percent of your current loan amount and many will also allow you to increase your regular repayments towards your home loan by up to $250 a week.
But if you need access to the money, an offset account might work, he says.
“Offset accounts are mostly linked to home loans with variable rates, which tend to have a higher interest rate than fixed-rate home loans. So it’s not wise to offset all of your mortgage, unless you’ve a huge amount of spare cash in the bank. Rather it’s a better idea to offset just a small part of your mortgage, to match any lump sum you have regularly sitting in your bank account.
“For example, if you’re self-employed and set aside money for your taxes and ACC, you could consider offsetting the account against your mortgage.”