When the Reserve Bank of New Zealand raised the official cash rate from 2.50 to 2.75 percentage points last month, the debate on whether it is better to have a fixed or a floating home loan began again. While the official cash rate remained at the all time low of 2.50 percent for so long, economists and financial planners were suggesting a floating interest rate would be the way to go. Now that it appears the Reserve Bank will raise the official cash rate again in the next few months, some homebuyers are wondering whether to fix the rates on their home loans. Which home loan is better?

Fixed Rates
The advantage of fixing the rate on your home loan is that you have no surprises when the official cash rate changes. Your loan repayments will remain the same, making it easy to budget. Fixed rates are currently higher than the floating rate, so you will pay more interest presently. However, if you lock in a low fixed rate now for the next three years, you’ll probably end up saving money as the floating rate rises with the official cash rate. The longer you fix your home loan rate, the higher interest rate you’ll pay. Fixing the interest rate for one year will give you a slightly lower interest rate than the three-year one, while giving you the security of stable repayments.

Floating Rates
The banks are still offering floating rates that are lower than a fixed interest rate home loan. When the Reserve Bank raised the official cash rate, homebuyers who had a $200,000 loan faced an increase of repayments of about $10 a week. The floating rate offers homebuyers the chance to pay off the loan quicker, by paying larger repayments when the interest rate is low. If you can afford to pay more than the minimum monthly repayment, a floating rate is a good idea, as you’ll reduce the home loan much faster. This also gives you some leeway so that when the official cash rate rises again, you don’t necessarily have to increase your repayments.

Comfort Zone
In the end, the decision of whether to fix or float your home loan interest rate depends on your comfort zone. If you want the security of stable repayments that will not increase when the official cash rate does, look at fixing your home loan now. If you want to pay off your home loan quickly and can afford to increase your repayments as the official cash rate rises, a floating rate is the option for you.

Future Expectations
Of course, the decision of whether to fix or float your interest rate does depend on what you expect the Reserve Bank to do with the official cash rate in the future. In the statement on the official cash rate rise on June 10, Governor of the Reserve Bank, Alan Bollard, said the further removal of stimulus would be “reviewed in light of economic and financial market developments.” There was no clear indication of whether the Reserve Bank would look at rising the official cash rate in the next few months or not.

“The fact that bank funding costs are higher, long-term interest rates are higher than short-term interest rates, and a greater proportion of borrowers use floating rate mortgages should all reduce the extent to which the OCR will need to be increased relative to previous cycles,” Mr Bollard said.

While it is almost certain that the Reserve Bank will need to raise the official cash rate again in the future, as the economy continues to improve, it is not certain when that rise will be. Meanwhile, the floating rate mortgage still provides mortgagees with cheaper rates than a fixed rate mortgage. Against the uncertainty of the future rises in costs, fixed rate home loans offer the security of fixed repayments.