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Is it time to grab a long-term fixed interest rate?

Until recently, the commentary around interest rates has been a bit like taking a roadie with young kids. It’s been dominated with that age-old question, ‘are we there yet?’ And just like the usual back seat pleading, we’ve also heard plenty of ‘how much further?’ and ‘I want an ice cream’.

In this case the destination has been the point at which interest rates reach their lowest point and begin to rise. The fixation has been a desire to lock in the lowest possible rate and enjoy the sweet cool taste of success as advertised rates steadily rise.

So, are we there yet?

A recent report from one of New Zealand’s largest banks says it’s time to think about fixing at least some of your mortgage on a longer term rate. But how can you decide whether that suggestion applies to you? Here are some of the main points to consider.
  • Long-term mortgage interest rates are expected to start rising soon
  • No-one can know exactly when
  • They’re not expected to rise particularly quickly or reach dizzying heights
  • For now, you might save money by waiting a bit longer or re-fixing for a short-term
  • However, if you’re financially stretched, it might not be worth taking the risk
  • Putting at least some of your mortgage on a long-term fixed rate now (before they rise) could give you a foot in both camps

Why are mortgage rates expected to start rising?

Mortgage interest rates depend on the rates that lenders, such as banks, have to pay to borrow the money they lend to you. They borrow from their depositors, the Reserve Bank and overseas wholesale lenders.

The Reserve Bank recently published ‘very conditional’ projections for its base wholesale lending rate, known as the official cash rate (OCR). They indicate a series of increases starting later in 2022 and reaching 1.75% by mid-2024. The OCR is currently only 0.25% and was 1% before Covid-19.

The Reserve Bank alters the OCR to control inflation. They are required to keep inflation, as measured by the consumer price index (CPI), to around 2%. Loosely speaking, increasing the OCR increases interest rates, decreases spending confidence, and that lowers prices and inflation. Decreasing the OCR has the reverse effect.

What’s going to happen with short-term rates?

Right now there’s still a competition going on to see who can present the most attractive short-term rate. Today, Heartland bank offers the lowest one year rate at 1.85% , Cooperative bank is next at 2.09%, closely followed by a host of other banks (ANZ, ASB, HSBC, Kiwibank, SBS and TSB) at 2.19%. However, it’s obvious that two-year and longer rates are sneaking up.

Without a crystal ball, it’s hard to predict when rate rises will start to affect shorter-term rates. The future for long-term rates is not nearly as clouded.

What’s happening to inflation in New Zealand?

It’s widely accepted that inflation is on the increase right now, but how long that will continue and how steeply it will rise depends on who you talk to. Some sources indicate it has almost recovered to 2% already and still has a way to go.

The Reserve Bank based its recent OCR predictions on a belief that the factors pushing up inflation right now are temporary.

ANZ’s economist predicts inflation will peak at 3% in the third quarter (July-September) of this year. They base this on the current ‘persistent’ pressures – such as higher Covid-19 shipping costs and a shortage of workers pushing up wages – not being permanent. They also point out that the substantial minimum wage increase earlier this year, as well as the low inflation from 2020 dropping out of the annual calculation, are other ‘one-off’ contributors to the 3% figure.

So, overall, ANZ sees the current strong employment and inflation as increasing the risk of higher interest rates.

How high will mortgage rates go?

Before the 2008 global financial crisis (GFC), despite fairly consistent mortgage interest rates of around 7%, New Zealand was experiencing persistent rises in inflation. To slow the economy, the Reserve Bank ended up having to raise the OCR from 5% in 2004 all the way to 8.25% in 2008. Then the global financial crash happened and the economy collapsed, which had nothing to do with the OCR. To stimulate the New Zealand economy, the OCR was slashed, dipping to 2.5% by April 2009. The government also introduced tax cuts to help get people spending again.

At the beginning of 2004, the variable (floating) and two-year fixed interest rates were around 7%. In 2008, just before the GFC, they peaked at 10.7% and 9.6% respectively. A year later as the GFC took hold, they had dropped to 6.4% and 6.2%.

Even though we’re now starting with the OCR at only 0.25%, commentators don’t expect to see such rapid and substantial change to interest rates this time around. The main reason is the high levels of household debt we now have. That means we’ll be much more ‘sensitive’ to interest rate increases. In other words, it’s possible that smaller rates increases will be enough to slow spending and reduce inflation.
Another reason suggested by the ANZ’s economist is that 78% of mortgages are currently either floating or fixed for less than a year. That’s a much higher percentage than usual. People have been expecting rates to fall, so they’ve probably ridden the market down and are now taking advantage of the lowest rates available, which are those with very short terms.

So, when the Reserve Bank does start to increase the OCR, a large number of mortgage borrowers will come off fixed and be affected by the increase within a year. The increase will therefore have a widespread and rapid effect, which means a more modest increase than in the past should get the job done.

How long should I fix my mortgage for?

With interest rates looking more likely to rise, many people may be choosing to fix or re-fix in the coming months. The question they’ll all have is ‘for how long?’.

At the time of writing, our home loan interest rates table showed fixed rates from one-year at around 2.2% to five years at around 3.7%. That’s a 1.5% difference, so it might be tempting to take the one-year rate. But what will the rates be like when you come off fixed in a year’s time and the year after that…and so on? No one knows for sure.

If you can afford the five-year 3.7% rate (but anything more is going to be financially tight) you might grab it for five years of peace-of-mind. On the other hand, if you can afford to take the risk, you might take a shorter term, use the difference to repay your loan faster and see what happens.

Reducing financial risk often involves not having all your eggs in one basket. In this case that could mean fixing some of your mortgage for a long term, like five years, and some for a shorter term. Whatever rates do, you’ll be partially protected. The short-term loan will also give you the option to repay lump sums when it comes off fixed. But your longer term loan could mean you can’t shop around for better mortgage deals, without having to pay early repayment charges.

Like many things in life, the best decision for you will depend on your circumstances. If you’re at all unsure, it’s a good idea to get professional advice from a specialist you trust, such as an independent banker, accountant or mortgage broker.

Hopefully this article has given you enough background to get started, ask the right questions and make a well-informed decision.

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