Fixed vs Floating Mortgage Rates — Which Is Right for You?

The choice between a fixed and floating mortgage rate is the most common fork in the road for NZ home buyers. Each does something genuinely different. Neither is universally better. The right choice depends on your financial situation, your risk tolerance, and what you expect interest rates to do — recognising that no one predicts rates consistently.

How Fixed Rates Work

A fixed-rate mortgage locks the interest rate for a set period, typically one to five years. Your repayment amount stays the same for that entire period regardless of what happens to the official cash rate or what other borrowers are paying. If rates go up, you are protected. If rates go down, you miss the saving until your fixed term ends and you refix at the new rate.

The fixed rate is set by the bank based on its cost of funds plus a margin. That cost of funds is influenced by wholesale swap rates — basically, what the bank pays to borrow money for that term in wholesale markets. When swap rates rise, fixed mortgage rates rise. When swap rates fall, fixed mortgage rates fall. The bank adds a margin on top to cover its operating costs and profit.

Breaking a fixed-rate contract early incurs a break fee, which can be substantial. The fee is calculated based on the remaining term and the difference between your locked-in rate and the current rate the bank could lend that money at. If current rates are lower than your fixed rate, the break fee is large because the bank loses the higher interest income. If current rates are higher, the break fee is small or zero. Break fees of several thousand dollars are not unusual for borrowers who break a two or three-year term partway through.

How Floating Rates Work

A floating rate changes whenever the bank decides to change it. Banks typically adjust floating rates in response to official cash rate changes from the Reserve Bank, but they can also change them independently. The rate floats, meaning your interest cost varies over time and your repayment amount changes when the rate changes, assuming the same remaining term.

The floating rate is always higher than the one-year fixed rate in normal market conditions. Banks charge a premium for the flexibility of a floating rate, just as they charge a premium for any product that gives the customer more optionality. The gap between floating and short-term fixed rates varies over time but is typically meaningful.

The main advantage of floating is flexibility. You can make extra repayments at any time without penalty — useful when you have a bonus, tax refund, or inheritance to put against the loan. You can also redraw any extra payments you have made, giving you access to that money if you need it later. Fixed-rate loans typically limit extra repayments to a small percentage of the loan each year without triggering a break fee.

The Common Strategy

Most borrowers split their mortgage into a fixed portion and a floating portion. A typical split might be seventy percent fixed and thirty percent floating. The fixed portion gives certainty on most of the debt. The floating portion provides flexibility for extra repayments and acts as a buffer if circumstances change.

The floating portion is also where most borrowers keep their emergency savings offset against the loan using an offset account. An offset account links your savings account to the floating portion of your mortgage. Instead of earning interest on your savings, the savings balance is subtracted from the floating loan balance before interest is calculated. The effective return on savings held in the offset account is your floating mortgage rate, which is higher than any savings account rate. This makes offset accounts a powerful tool for borrowers who have significant cash reserves.

Refixing Timing

When a fixed rate term ends, the bank offers new fixed rates across all available terms. You can pick any term — not necessarily the same one you used before — or switch to floating. Shopping around at refix time is worthwhile because different banks offer different rates at different times, and the relationship between one-year, two-year, and three-year rates changes as market conditions evolve. A broker can compare offers across multiple lenders at refix time just as they do for a new mortgage.

Which Term to Choose

One-year rates are typically lower than longer-term rates in a normal market, reflecting the lower risk for the bank of lending for a shorter period. The trade-off is that you need to refix more often, exposing you to rate changes each year. If rates are rising, a one-year fix locks in a low rate for only twelve months before resetting at a higher rate.

Two and three-year rates are the most popular choices. They offer a balance between rate certainty and flexibility. The rate is usually higher than one-year but lower than five-year, and the term is long enough to get through a rate cycle without multiple refixes. Most borrowers who take a two or three-year fix are happy with the result.

Five-year rates are higher than shorter terms in most conditions. The bank charges a premium for locking in its funding cost for five years. The longer term suits borrowers who prioritise payment certainty and do not want to think about refixing for several years. The trade-off is paying a higher rate for that certainty and facing a larger break fee if circumstances change and you need to sell or refinance early. Five-year fixes are less common in New Zealand than shorter terms, but they are the right choice for a specific type of borrower: someone who values stability above all else.

The right term depends on your personal circumstances rather than on predicting interest rate movements. A two-year fix is the default for most borrowers because it balances the competing priorities of rate certainty and flexibility. Adjusting from that default based on your specific situation — knowing you will need to sell in eighteen months, wanting maximum flexibility, or wanting maximum stability — makes more sense than trying to outguess the market.

Crunch the numbers yourself: Use our Mortgage Repayment Calculator to see what your monthly payments could be at different interest rates and loan terms.