The Bank of NZ has dropped its two-year fixed interest rate to a "historic" 3.99 per cent as it returns fire in a burgeoning mortgage war between the country's lenders.

ANZ - the nation's largest bank - last week offered the lowest rate by a major bank since just after World War II with a fixed one-year term of 3.95 per cent.

It then followed this up by offering a $3000 cash back incentive for customers, who took out a new home loan and committed to keeping their mortgage with ANZ for three years.

Westpac also announced it will match ANZ's offer of a one-year fixed rate at 3.95 per cent, beginning tomorrow.

Smaller banks had earlier tempted customers with rates under 4 per cent during the past month but major lenders have not dropped so low since the 1940s. The highest rate on record was a staggering 19.72 per cent in 1988.

Loan Market mortgage adviser Bruce Patten says spring is traditionally the time when banks released interest-rate specials, but the current low rates showed they were in a fight for customers.

"It means banks are trying to stimulate activity so they are giving up a bit of margin to get a crack at the small volume of lending around," he said.

"It is great for the consumer because we have some really low rates."

The banks' new low rates come after a near decade long boom of skyrocketing Auckland house prices drove values to unaffordable levels that locked many people out of home ownership.

The subsequent drop in demand and new Government restrictions targeting investors led prices and sales volumes to then plateau and largely remained flat throughout this year.

However, October had brought an uptick in prices and the number of house sold, Barfoot and Thompson managing director Peter Thompson said.

These signs of a Spring bounce combined with the banks' new low rates led some pundits to question whether there would now be a rush of new buyers entering the market, who would once again push prices up.

But CoreLogic senior analyst Nick Goodall didn't believe the new low rates would bring significantly more buyers into the market.

This was because responsible lending laws require banks to still run stress tests on the finances of potential buyers to ensure they can afford to pay mortgages at rates higher than 7 per cent.

"The banks' focus is still on stringent income tests, making sure a [borrower's] income is valid, and they can afford the mortgage and serviceability test," he said.

"So even though you can secure these loans under 4 per cent, they are making sure that if there was a 7 per cent interest rate tomorrow that people can pay on that as well."

This showed that while banks have an appetite for more customers, they were still picky about who they lent to, "which is why we are not seeing a massive increase in new borrowers or house sales".

The low rates were therefore as much aimed at stealing existing customers from other banks as they were at attracting those taking out new home loans.

"So if someone comes to the end of a fixed term rate ... they might sit there and go, 'Oh, maybe we should go across to ANZ or BNZ or whatever it is', whereas otherwise they might just stick with their current bank," he said.

"So the refinance game is up as well."

The low rate specials offered by ANZ, BNZ and Westpac are only available to home owners with a deposit or 20 per cent equity stake in their homes.

ANZ's $3000 cash back offer, however, is available to customers with less than 20 per cent equity in their homes, according to Loan Market's Patten.

BNZ chief economist Tony Alexander said "sustained low inflation, the effectiveness of the Reserve Bank's LVR rules and the recent cooling in the New Zealand housing market in spite of still strong economic growth" had given the bank the confidence to offer the rates.

Bank general manager retail network Logan Munro, meanwhile, called his bank's new two-year rate "a real bonus for both current and aspiring home owners who can have the confidence of locking in an interest rate not seen in BNZ's proud history".

SHOULD YOU REFINANCE?

• To check whether it's worth breaking the contract on your current home loan to take advantage of the new low interest rates, you'll need to ring your mortgage broker or bank
• They'll tell you how much your fee is for ending your home loan contract early
• You need to then calculate whether the fee is going to add up to more than the money you will save from reduced interest payments. But beware, if the fee is large, you may have to add it to your home loan and then pay interest on it as well
• Loan Market mortgage advisor Bruce Patten says most people will find they either save no money or lose money if they break their contract. However, he said its worth calling your broker or lender because the odd person will be able to save cash=