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Structuring your mortgage

Structuring your mortgage

February 21, 2024

Reducing exposure to interest rate changes

Interest rates in New Zealand are relatively volatile. In 2021 rates dropped to around 2%, whereas today, just three years later, one-year rates with the big five banks are over 7%, leaving many households paying up to three times as much in interest costs.

While there’s no way to avoid high rates other than crystal ball gazing, we encourage many of our clients to use a method called interest rate averaging. This works by splitting your mortgage into smaller loans which spreads the risk across different lengths and different interest rates.

This means that on expiry of one of the terms, if interest rates had increased, only apportion of your lending would be exposed to the higher rate. Your average rate would still increase, however it would be lower than if all your lending expired.

Using interest rate averaging allows borrowers to better manage their repayments. Increased rates will still result in higher repayments but the impact can be softened.

The downside is the flipside. If interest rates decrease, only a portion of your mortgage would be subject to the lower rate.

Assessing your requirements comes down to the individual situation. What is your tolerance for risk? Where do you see the interest rates going? For those with a favourable outlook, amore aggressive structure could be an effective balance. Similarly, if you're more concerned with costs not increasing, you might be best to split your mortgages across longer periods.

Offset loans

Offset loans are a powerful way to help you reduce interest costs and provide flexibility to make additional repayments. In a nutshell, they work by reducing the amount you pay interest on by the value of your linked accounts.

For example, if you have a total offset loan of $100,000 and savings of $25,000,you only pay interest on $75,000.

This type of loan can be very useful for people who earn varying amounts across the year, e.g. self-employed or commission based employees as it provides a lot of flexibility to make additional repayments as needed.

The benefited offset accounts are useful to most borrowers, but there are some negatives to be aware of.

The biggest negative is higher interest rates. Offset loans are based on variable rates which are typically up to 2% higher than the one-year fixed rate. However, with the correct structure this negative can be minimized as the amount split for the offset should be more manageable. For example in the scenario above, if you had savings of $25,000 you might set your offset loan to be $50,000 to enable you to keep earning and reducing the balance, without paying the higher interest rate on too a large balance.

For more information and tailored advice to suit your situation, contact us for a free, no-obligation chat.

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