New numbers suggest sticking with a one-year fixed term on your mortgage is probably going to cost you less than fixing longer term, despite interest rate rises. But it’s an uncertain call.
On August 18, the Reserve Bank was set to make a relatively momentous decision, not least for homeowners. For the first time in seven years, it was looking to raise interest rates. Nay, it was almost certain to raise interest rates, moving the official cash rate, or OCR, from its historic low of 0.25 percent.
The only questions were by how much – up to 0.5 percent, or 0.75 percent? And then when would it go up again – and where would that stop: 1.5 percent? 2 percent?
Analysts were talking about possible RBNZ targets for the official cash rate of more than 2 percent in 2023.
Interest rate rises mean decisions for home owners: should they look to lock in the lower rates by choosing a two, three or even longer fixed rate mortgage when their loan comes up for renewal?
Earlier in the year, the answer to that question might have been a tentative yes. Things have changed.
As we all know, at 11.59pm on August 17, just hours before the Reserve Bank decision, New Zealand went into Level 4 lockdown. The Reserve Bank knocked its rate rise on the head – no point making things more stressful for businesses and homeowners by increasing their debt payments.
Economists are still predicting rises – they expect them to start in October or November and go into next year. The endgame for the Reserve Bank, they reckon, is the OCR being between 1.5 and 2 percent within 12 months, maybe higher in 2023.
The OCR influences mortgage rates, so they would go up too. But lockdown makes everything more uncertain.
Uncertainty is hard for homeowners with mortgages – there’s a lot of money at stake. Kiwis owe almost $315 billion on their mortgages, according to the most recent Reserve Bank figures.
So what to do?
New numbers from Canstar, a bank research and ratings company, don’t try to second guess the OCR or any mortgage interest rates rises.
“The rate increase we are calling for is conditional on things going right. Beating Delta, and an upturn after. The market is looking to the experience in 2020: strong GDP, strong inflation, low unemployment, but there were a whole lot of factors driving recovery at that time, from a strong housing market generating a wealth effect, to people making one-off purchases of new stuff. That’s not necessarily going to happen this time.”
– David Croy, ANZ
What they do is to put a number on the level of interest rate increase where it becomes better financially for a homeowner to fix for a longer term – say two years or four years – rather than stick with a one-year fixed term.
That’s relevant because approximately 86 percent of that $300 billion or so in lending in New Zealand is in fixed-rate/set period (as opposed to floating) mortgages, according to Consumer.co.nz.
And over 2021, more than 70 percent of owner-occupiers will be making the decision about what to do with their fixed rate mortgage – go long or go short, Consumer says.
Making the right (or the wrong) decision can mean paying thousands of dollars less (or more) on your mortgage.
Start with the premise that the longer you fix your mortgage for, the higher the interest rate will be. That’s because guaranteeing an interest rate over four or five years is riskier for a bank, because who knows what might happen in the economy in the meantime – earthquakes, pandemics, terror attacks. So customers are basically paying extra to the bank to cover that additional risk.
So from the table above, if you were taking out a mortgage today, the minimum one-year fixed rate would be 2.39 percent. For two years it’s 2.79 percent and for four years 3.39 percent.
For the median-priced New Zealand home ($820,000 in June, according to the Real Estate Institute) with an 80 percent mortgage and a 30-year loan, you’d pay around $6,500 extra interest over the first 12 months with a four-year fixed term, compared with a one year, according to Canstar ($22,040, compared with $15,513 in the table above).
But watch how the numbers reverse as the interest rate rises.
If the mortgage rate for our median homeowner rises 0.69 percent each year for four years, by year 4 they are paying approximately $6,400 ($27,062 minus $20,669) more than if they had fixed for four years.
“I like playing with interest rates, and I locked part of my mortgage at 2.99 percent for five years and then a bit more at 3.11. It means if we do get a hike, at least I know a part is fixed.”
– Jarrod Kerr, Kiwibank
It’s what Canstar is calling the “breakeven point”: the annual interest rate rise at which the amount of interest the homeowner will pay over the four year period is the same whether they re-fixed once or four times.
It’s 1.24 percent if they are on a 2-year fixed term.
There are a few caveats, but in theory, if the annual mortgage interest rate increase is lower than 0.69 percent, our homeowner will be better off fixing every year; if it’s more, they would be better off with a four-year fixed mortgage.
Given that analysis, mortgage holders can make their decision based on where they think interest rates are going to go, says Canstar NZ general manager Jose George.
How can we tell where the mortgage rate will go? The answer is of course that we don’t know, George says. But there are some ways to raise our decision-making criteria above the level of wild guess.
One is to look at history, he says. What has happened when interest rates have risen in the past?
Since the Reserve Bank first launched the OCR in March 1999 (at 4.5 percent) there haven’t been that many times when it has risen. The most recent was between 2013 and 2015. Canstar crunched some numbers about that too.
The figures show over that three-year period, 2013-2015, average interest rates on 1-year fixed mortgages went up from 5.35 percent to 5.89 percent – about 0.5 percent overall - before dropping down again in 2016 to 4.66 percent.
Even at its peak – year 3 in the table above – that mortgage rate increase wasn’t enough to make it better for a homeowner to fix for four years, rather than year by year.
Instead a homeowner would have saved just over $8000 sticking with one-year fixed terms, according to the numbers.
In Auckland, the difference is even wider – just over $11,800 less in interest payments.
Still, it's tricky using these figures as a guide, says Kiwibank chief economist Jarrod Kerr. Interest rates are at historic lows these days, so you might expect them to go up more. Then again, they might not.
As an aside, looking at the “loan amount” figure towards the top left of the tables shows just how crazy the housing market has become over the past 10 years.
Nationally, Canstar is using a median loan amount (representing 80 percent of the house price) of $656,000 for its 2021 table, compared to $278,400 for 2013-2016.
In Auckland, it’s $920,000 versus $402,000.
Where the experts see interest rates going
Kiwibank's Jarrod Kerr says homeowners have an unenviable decision. Earlier in the year, there was a bigger incentive for mortgage holders to think about fixing their rates for a longer term. Home loan interest rates were low, but there were suggestions of Official Cash Rate rises.
“We were pounding the table in April/May about fixing long term rates,” Kerr says.
More recently, however, banks have started factoring the anticipated RBNZ rate rise into their mortgage rates, lifting them.
That reduces the potential benefit of fixing for a longer term because the future rate rise might be smaller.
Kerr, a self-confessed nerd when it comes to economic numbers, splits his own mortgage into chunks which he fixes for different time periods between one and five years. But he moved more of his own mortgage longer-term earlier this year.
“I like playing with interest rates, and I locked part of my mortgage at 2.99 percent for five years and then a bit more at 3.11. It means if we do get a hike, at least I know a part is fixed.”
'What a difference a month makes'
ANZ senior strategist David Croy says the latest lockdown has increased uncertainty about the economy, and that could impact the Reserve Bank’s decision on interest rates - and therefore mortgage rates.
Most people are picking economic strength coming out of lockdown - because that’s what happened last time. But pundits have been wrong before.
“The rate increase we are calling for is conditional on things going right. Beating Delta, and an upturn after.
“The market is looking to the experience in 2020: strong GDP, strong inflation, low unemployment, but there were a whole lot of factors driving recovery at that time, from a strong housing market generating a wealth effect, to people making one-off purchases of new stuff.
“That’s not necessarily going to happen this time.”
Every month, Croy writes a column in ANZ’s Property Focus about what people should consider when fixing their mortgage.
“What a difference a month makes,” he says in the August issue, published after Level 4 lockdown started. “What we described a month ago as a line call between 1-year and 2 or 3-year is now skewed more towards the former. That’s because longer-term fixed rates are higher, yet the risk that the RBNZ’s plans are further derailed seem to be greater."
Still, inflation risks remain, Croy says "so it’s not one-sided.”
ANZ has also been crunching numbers, looking at how much bank mortgage rates would need to rise over the next 24 months to make fixing for two years cheaper than back-to-back one-year fixes.
“Our analysis is you’d need to expect the 1-year rate to rise 0.75 percentage points (from 2.59 percent to 3.34 percent),” Croy says.
“To be clear, our forecasts have the OCR rising by more than that over the next year. However, we have already seen the 1-year rate rise by 0.40 percentage points since June... and the outlook is now much less certain.
“So again, it’s a line call, but perhaps one shaded more towards fixing for shorter, and/or holding off to see how things look in a few weeks."
Canstar’s Jose George comes to a similar conclusion.
“It’s an incredibly volatile environment with Delta arriving, and there’s no magical solution for borrowers,” he says. “The Reserve Bank is still making noises about raising, but a 500 percent increase in the base rate [from 0.25 percent to 1.5 percent] in an over-leveraged society, where people have extended themselves with their mortgages, has the potential to create havoc.”
The Reserve Bank will be waiting to see before making a decision about mow much and how fast to lift interest rates, but in the meantime, there are a lot of home owners with mortgage terms coming to an end and having to make a decision.
“Overall, our analysis and historical data suggests homeowners will probably be better off financially if they fix at shorter-term rates over the foreseeable future," George says.
On the other hand, some people prefer to have some long-term certainty over what their payments will be.
“Some people may prefer the stability of a longer-term mortgage rate, with repayments known in a world where instability has become the norm. Others will feel comfortable with shorter-term fixed rates, hoping it will pay off financially.”
You pays yer money and you takes yer choice.
