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October 09 newsletter

Should you fix? And if you fix, for how long?

In the good old days (about 12 months ago), it was easy to decide which interest rate to go with. In those halcyon days, New Zealand was blessed with an interest rate scenario where the longer-term rate was cheaper than the floating rate. Why was that a blessing? Because you should have to pay for certainty. That is, you should have to pay a premium to lock in your preferred rate. Back in the days of Dr Cullenís fine stewardship, you actually got a lower interest rate if you locked in for a longer period. How good was that? Well, too good to last.

Today, we face normal economic times where you have to pay a premium to guarantee an interest rate for a period of time. For example, the six month interest rate can be as low as 5.75%, while at the same time the three year term can be as high as 7.75%. So the first question is do you fix or float? The second question is how long should you fix for? In the above example, do you lock in a higher rate, knowing that it canít be changed for three years? Do you take this option, which offers the family budget certainty or do you take the lower short-term rate and use the extra cash to pay down debt over the next three years? (obviously 12 months ago, you would have used the cash to buy a bigger flat screen TV).

Here is some help

One way to help answers those questions is to follow the National Bankís Property Focus report.

In this newsletter, the Shape of Money has followed up a useful break-even calculation proposed by the National Bank in their May 09 publication.

A simple example

Letís take a simple example (and let the break-even mortgage interest calculator do the work on more complicated scenarios).

The fixed interest rates are 7% for one year 8% for two years. Should you fix for one year or two years? This decision will ultimately depend on your personal circumstances. However, if we just consider the level of interest rates over the two year period, it would be advantageous to fix for just one year if you believe that in 12 months time, the one year fixed term will be less than 9%.

That is, year one at 7% and year two at 9% is the approximate equivalent of 8% over two years (7+9/2). So, if for example you were able to fixed for another 12 months in the second year at 8.50%, your average interest rate over the two years would be 7.75% (7+8.50/2), which is obviously less than the 8% 2-year fixed rate.

Confused? No worries, because your financial adviser, banker or mortgage broker will only be too happy to take you through your personal options.

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