Interest rates are one of the most significant factors influencing your mortgage. They determine how much you’ll pay over the life of your loan and can directly impact your financial decisions. Here’s an in-depth look at how interest rates work, how they’re set, and how they affect your mortgage.
What Are Interest Rates?
An interest rate is the cost of borrowing money from a lender, expressed as a percentage of the loan amount. For mortgages, the interest rate determines how much extra you’ll pay in addition to repaying the principal (the original loan amount). Even small changes in interest rates can have a big impact on your overall costs.
How Are Interest Rates Set in New Zealand?
Interest rates in New Zealand are influenced by several factors:
- Official Cash Rate (OCR): Set by the Reserve Bank of New Zealand (RBNZ), the OCR affects how much banks pay to borrow money. When the OCR changes, banks usually adjust their mortgage rates accordingly.
- Global Economic Conditions: Factors like inflation, international trade, and global market trends can influence interest rates in New Zealand.
- Bank Competition: Lenders compete for customers, which can lead to variations in mortgage rates across banks.
- Borrower Risk Profile: Your credit score, income stability, and loan-to-value ratio (LVR) can also affect the interest rate you’re offered.
Fixed vs. Floating Rates
When choosing a mortgage, you’ll typically decide between a fixed interest rate and a floating interest rate. Here’s how they differ:
1. Fixed Interest Rates
- Advantages:
- Your repayments remain consistent for the fixed term, making it easier to budget.
- You’re protected from interest rate increases during the fixed period.
- Disadvantages:
- If rates drop, you won’t benefit from lower repayments.
- Break fees apply if you want to end your fixed term early.
2. Floating Interest Rates
- Advantages:
- Your rate fluctuates with market conditions, allowing you to benefit from rate decreases.
- You can make extra repayments or pay off your loan early without penalties.
- Disadvantages:
- Monthly repayments can increase if rates rise, making budgeting less predictable.
How Changes in Interest Rates Impact Your Mortgage
1. Monthly Repayments
A higher interest rate means higher monthly repayments, while a lower rate reduces them. For example, on a $500,000 loan over 30 years:
- At 5% interest, your monthly repayment is approximately $2,684.
- At 6% interest, your monthly repayment increases to $2,998.
2. Total Interest Paid
Even small rate changes significantly affect the total interest paid over the life of the loan. Using the same $500,000 loan:
- At 5%, you’d pay around $466,000 in interest over 30 years.
- At 6%, this rises to $579,000.
3. Borrowing Power
When rates increase, lenders may reduce the amount you can borrow because your repayments will take up a larger portion of your income. Conversely, lower rates can increase your borrowing power.
4. Equity Growth
Lower interest rates allow you to build equity faster since a greater portion of your repayments goes toward reducing the principal rather than paying interest.
Tips to Manage Interest Rate Changes
- Stress Test Your Budget: Plan for potential rate increases to ensure you can afford your repayments if rates rise.
- Consider Splitting Your Loan: Divide your loan between fixed and floating rates to balance stability and flexibility.
- Shop Around: Work with a mortgage adviser to help compare interest rates with multiple lenders and find the best deal.
- Make Extra Repayments: When rates are low, consider paying more toward your principal to reduce your loan term and total interest paid.
- Refinance When Appropriate: If rates drop significantly, refinancing your mortgage could save you money. Be sure to ask your mortgage adviser to help weigh the costs of refinancing against potential savings.
Need Expert Guidance?
Understanding how interest rates affect your mortgage is crucial to making informed decisions. At Lumen Financial, we specialise in helping Kiwis navigate the mortgage process and find the best solutions tailored to their needs. Whether you’re a first-home buyer, investor, or looking to refinance, our team can provide expert advice and support.
Get in touch with us today to explore your options and stay ahead in a changing market.
