Why Should You Understand Interest Rate Types for Home Loans?

Choosing the Right Interest Rate for Your Home Loan

When you're looking at home loans in New Zealand, one of the most important decisions you'll make is choosing your interest rate type. It might seem overwhelming at first, but understanding the differences between floating rates, fixed rates, and combination options can save you thousands of dollars over the life of your mortgage.

Let's break down the main interest rate types available for your residential mortgage and help you figure out which option might work for your situation.

What is a Floating Rate Mortgage?

A floating rate mortgage (also called a variable rate) means your interest rate can move up or down at any time. When the Official Cash Rate changes or when lenders like ANZ, ASB, BNZ, Westpac, or Kiwibank adjust their rates, your mortgage rate will typically follow.

With a floating rate, you'll have maximum flexibility:

• Make extra repayments whenever you want without penalty
• Pay lump sum payments to reduce your principal faster
• Access features like redraw facility or offset mortgage options
• Break your loan without facing break fees

The downside? Your repayments can increase when rates go up, making it harder to budget with certainty. Many homeowners find floating rates work well when rates are falling or expected to drop, or when they're planning to sell their property soon.

Understanding Fixed Rate Mortgages

A fixed rate mortgage locks in your interest rate for a set period - typically 1 year fixed, 2 year fixed, 3 year fixed, or 5 year fixed terms. During this time, your mortgage rate won't change regardless of what happens in the broader market.

The advantages of fixing include:

• Certainty in your repayments for budgeting purposes
• Protection if interest rates rise
• Peace of mind knowing exactly what you'll pay

However, fixed rate mortgages come with restrictions. You'll usually face penalties for making extra repayments beyond a certain threshold (often around $10,000 per year). Breaking a fixed rate contract early can result in significant break fees, particularly if rates have dropped since you fixed.

When comparing carded rates from different banks and lenders, remember that special rates are often available through a mortgage broker who can negotiate on your behalf.

The Middle Ground: Split Loans and Combination Loans

Can't decide between fixed and floating? A split loan (also called a combination loan) lets you divide your home mortgage between different rate types. You might put 50% on a floating rate and 50% on a 2 year fixed rate, or split it three ways across different fixed terms.

This approach offers several benefits:

• You get some certainty while keeping some flexibility
• You can make extra repayments on the floating portion
• You're not fully exposed if rates move in either direction
• You can fix different portions for different terms, hedging your position

Many professionals across New Zealand use this strategy to balance security with opportunity. Your mortgage adviser can help you determine the right split based on your borrowing capacity and financial goals.

What About Principal and Interest vs Interest Only?

Beyond choosing your interest rate type, you'll also need to decide on your repayment structure. Most owner occupied home loans use a principal and interest structure (sometimes called a table loan), where each repayment reduces both the interest charged and the loan principal.

An interest only loan means you only pay the interest portion for a set period, keeping repayments lower but not reducing your debt. This structure is more common for investment loans rather than your first home loan or upgrader loan.

How LVR Affects Your Interest Rate

Your loan to value ratio (LVR) significantly impacts the rates you'll be offered. If you're borrowing:

• Up to 80% LVR (20% deposit) - You'll access standard rates
• Between 80% and 90% LVR (10% deposit) - You might pay a low equity margin (LEM)
• Above 90% LVR (5% deposit) - A Low Equity Premium (LEP) typically applies

For those looking at low deposit home loans with a 5% deposit or 10% deposit, the LEP or low equity margin adds to your interest rate. The deposit requirement varies between lenders, so shopping around through a mortgage broker can help you avoid LEP where possible or minimize its impact.

Calculating What You Can Afford

Before settling on an interest rate type, use a home loan calculator or repayment calculator to understand how different rates affect your repayments. These tools help answer the common question: how much can I borrow?

Your borrowing calculator results will vary based on:

• The interest rate you choose
• Your income and existing debts
• The loan term you select
• Whether you're choosing principal and interest or interest only

A mortgage adviser can provide more accurate calculations specific to your situation and the current rates available from different lenders.

Making Your Decision

There's no one-size-fits-all answer when it comes to choosing between fixed, floating, or split rates for your house loan. Your decision should consider:

• Your comfort with risk and uncertainty
• How long you plan to stay in the property
• Your ability to absorb repayment increases
• Current market conditions and rate trends
• Your overall financial situation

Whether you're looking at your first home loan, considering refinancing your existing mortgage, or exploring property loan options as an upgrader, taking time to understand interest rate types will serve you well.

Working with a professional mortgage broker gives you access to multiple banks and lenders including ANZ, ASB, BNZ, Westpac, and Kiwibank. They can compare current rates, explain home loan features like revolving credit or offset mortgage options, and help you structure your home loan New Zealand to match your goals.

Your home mortgage is likely the largest financial commitment you'll make. Understanding how different interest rate types work puts you in control of that decision. Call one of our team or book an appointment at a time that works for you to discuss which interest rate structure suits your circumstances and financial objectives.