Mortgage dilemma: Should you fix your home loan for one, two or more years?

Interest rates are rising but should you fix for one, two or three years? Photo / 123RF

It's the dilemma many home loan borrowers are facing.

Should you fix for one year now and pay less with the hope that rates will have topped out by the time you come off that term?

Or lock in a two or three-year fixed term and pay more now with the aim of avoiding the peak of the rates?

According to research and rating firm Canstar the one-year rate would need to rise from its current average of 4.63 per cent to over 5.97 per cent this time next year - to make it worthwhile fixing for two years right now where the average rate is 5.29 per cent.

Jose George, Canstar New Zealand general manager, said its calculated break-point was illustrative and there was no perfect answer as it depended on a person's individual situation and how future events affected rates.

"If you have a view that inflation will ease sooner than the current expectations, the lower rates of a one-year term or even a floating rate might appeal. And at the opposite end of the spectrum, a more costly five-year term will provide stability of payments through what could be a tumultuous next few years.

"If you believe retail rates will be below the break point in a year's time, you should be better off taking a one-year fixed term. If you believe rates will be higher than that in a year's time, it may be advantageous for you to lock in the two-year rate."

The official cash rate is forecast to rise from its current 2 per cent to 3.9 per cent by this time next year, although economists are picking that it may only get as high as 3.5 per cent.

It has some impact on the bank mortgage rates but they are also influenced by how much banks pay depositors in interest and wholesale funding rates for banks which are impacted by international events.

Bruce Patten, a mortgage broker at Loan Market, said nobody knew exactly where rates would be in a year's time.

"What we are doing with our clients is saying 'look wherever the market sits it comes down to are you going to be in a worse financial position in a year's time if you fix for one year and the rates go up significantly? And if you are - you don't have a choice you have to fix for longer."

He said a lot of clients were splitting their mortgage and putting some on a one-year fixed term and some on three years if they couldn't afford to have it all jump up in a year's time.

"If they have strong affordability most of them are taking a 12-month view and because they know they can afford the higher rate and so they are going let's see where this takes us."

A small number were also fixing for five years. The average five-year rate is currently 6.11 per cent.

"They tend to be the more conservative people that just want to know what they are paying. But it's not many though - it would be a very small percentage of the total people that are fixing."

Patten said he had started to see a slowdown in the rate increases from the banks.

"Even though we have had OCR movements they haven't pushed the rates up as much or as high. So that's a somewhat encouraging sign that maybe we are nearing the peak but we have no idea because there is so much unknown out there at the moment."

New home loan borrowers who bought in the last two years are likely to be under the most pressure. Photo / Dean Purcell.

Last month the Reserve Bank increased the OCR from 1.5 per cent to 2 per cent and it took several days before the banks made a move.

While all increased their floating rates Patten said only 10 or 20 basis points was added to the one and two-year fixed terms and most kept their longer term rates static.

That compared to the previous OCR increase where the banks lifted shorter-term rates by around 35 basis points.

"That gives us a little bit of an indication that maybe we are nearing topping out of some of the longer-term fixed rates."

Patten said rising rates were tough but many borrowers had overpaid their mortgage over the last few years keeping their repayments the same even though interest rate dropped dramatically.

"Not quite but nearly half the [mortgage-holding] population won't be affected by the rate increases because they kept paying the higher amount."

He said those most affected were likely to be people that bought property in the last two years and never experienced anything other than a rate in the 2s.

"They probably would have paid the minimum from the start and pushed themselves to the maximum so they are the ones that will be most impacted."

He said people in that situation were best to talk to their bank if they couldn't afford to pay a higher interest rate.

Those who had equity of at least 20 per cent may be able to go interest only for a period of time to give themselves time for their income to rise.

"The good thing with the young ones is they are at the beginning of the income journey so they tend to be getting bigger increases. Young ones are quite resilient and are more likely to go and get flatmates if they didn't have them already."

He said some people would get hurt by the higher rates but in general borrowers were managing.

"I haven't had any really distressed scenarios - not to the extreme."

Patten said mortgagee sales were picking up but were nowhere near the levels seen during the Global Financial Crisis.

George said its calculation was illustrative and at a particular point in time.

"We know rates are moving rapidly, and so the math will change.

"But this does offer a way to try and de-risk your decision-making at a very volatile time. We know that locking in a good rate for an appropriate time can deliver significant savings in the household budget.

"So it's worth speaking to advisers, reading up on factors that influence the market, and then making a decision based on where you think the rate will be at a set point in the future."