The best short-term rates at the moment range from 5.20% to 5.50%. If you are buying a new property or simply refixing then this post wraps some important logic around my view that short-term rates are better value.
If you are buying a new property it might simply be easier to have us do everything for you (apply online.) After all, you should not have to know everything about interest rates!
Why Short-Term Rates?
The Reserve Bank has committed (as much as it can) to holding rates low for the foreseeable future and why wouldn’t they. We are in a major recession that will hang around for a long while yet! Just consider the downstream impact of the rising unemployment rate and reduced dairy payouts.
I’ll explore it further later but my view is that the highest 1 year housing rate in the next 5 years will be 8.50% based on the OCR getting to 7%.
If 8.50% is the worst we will see rates (my view) then is it all that bad? For example, on a $300,000 mortgage the monthly repayments at 5.50% using a 25 year term are $1,842 per month. At 8.50% using interest-only the repayments are $2,125 per month. So even with rates as high as 8.50%, an extra $300 per month is hardly the end of the world!
Long-term rates only look attractive if you buy into mortgage rates shooting back up to 9.50% again. In my mind this wont happen anytime soon and is irrational fear.
Dig Deeper
Ok, time to dig deeper. Start by having a look at the following graph. It shows the OCR history for NZ and Australia.
The first obvious point is how long it took rates to peak from when they started rising – 4 years. The second point is how slowly rates increased in Australia (because 70% of their market is on floating rates.)
Historically the Reserve Bank has had to hike interest rates up quicker and further then it would like because Kiwis have been locked into fixed rate home loans. In Australia, most home owners are on floating so the Reserve Bank of Australia has been able to increase rates more gradually.
With long-term rates so high in NZ, borrowers are choosing short-term rates. So our housing book is starting to look more like Australia. When rates do eventually increase this means the impact will pass through to borrowers more quickly thereby putting less pressure on further rates increases. In a perverse way, high long-term rates are helping convert more Kiwis to floating or short-term fixed rates.
The Geek Side of Me – Future “Implied” Rates
Analysis my mortgage team did at ANZ 5 years ago showed that short-term rates outperform long-term rates 82% of the time. Although that analysis is old I think it still holds true today, especially now with long-term rates so high. That means you are better-off taking consecutive short-term rates than a 5 year rate.
The following graph shows the implied forward housing rates today. If you believe the 1 Year mortgage rate will track above this level then you are better-off in long-term rates. If you believe rates track below this level you are better-off in short-term rates.
Based on current mortgage rates, the 1 year rate needs to get to 10% within 3 years for the current 5 year rate to be considered “good value.”
I’ve put my view of what the 1 Year Fixed rate will look like (for comparison) and calculated out the difference in actual cost. What you can see is that if mortgage rates follow my forecast you’ll be 1.30% better-off choosing a rolling 1 year rate over the 5 year rate. Naturally the cost/benefit equation will depend on your view of future mortgage rates.
Higher Funding Costs is a Red Herring
The banks have their highest home loan margins in over 10 years, which is a function of having to pay much more than normal for deposits (robbing Peter to pay Paul.) Ironically, as I have discussed in an earlier blog, Kiwi Bank is a key driver of the “Deposit Price War” as it has pushed up retail deposit rates to fund its housing growth. (They didn’t talk about that at the Parliament Finance Committee!)
High margins are already compensating banks for higher funding costs. When funding pressures eventually come off we will likely see long-term mortgage rates drift down a bit from current levels. Ironically it is currently cheaper to fund offshore than with retail term deposits. This is a temporary insanity!
In Summary
- More Kiwis are choosing short-term rates. This will make the OCR a more effective tool in the future and slow down any rate increases.
- Implied forward rates suggest that long-term rates are at least 1% overvalued.
- There is plenty of “margin” in the system for the banks provided they do not get too silly pricing domestic term deposits.
- Greater financial regulation and tighter credit rules will keep the brakes on lending growth, which in turn will keep less pressure on interest rates.
Who Are We?
Squirrel is an independent Mortgage Broking and Advisory business. We are happy to help you get the best out of your mortgages whether that is buying property, refinancing or simply restructuring everything to make it work better. Have you thought about doing a review of your current mortgage. If you are buying a new home then you can apply online with us and we’ll save you a bucket load of money, time and stress.
