ASB, ANZ, and National Bank increased their two-year through to five-year mortgage rates last week. Generally the one-year Rate is down at around 5.40% and the five-year is up around 8.20% to 8.30%. That is almost a 3% difference in rates! Increasing rates are likely to stir some level of fear amongst those closely following rates. I’ve been reading a few other blogs related to interest rates and some comments are enough to scare your pants off. DON’T PANIC!
Quick summary
I’m still fairly relaxed about rates. My view is still to split your mortgage into multiple parts and fix using short-term rates (floating through to 18-month fixed.) Based on my forecast of mortgage rates you will SAVE between 8% and 20% on your interest costs by using consecutive one-year fixed rates rather than a five-year fixed rate. This post explores how to do that in more detail.
My background
If you are new to this blog, by way of background I was previously general manager products at ANZ National Bank, responsible for the bank’s lending and deposit products. Prior to this I had various senior roles at Westpac, including managing interest rate risk for the bank.
What’s in it for me? This post is worth reading to give you a framework for picking your mortgage rates in the future and not breaking into a cold sweat every time someone says rates are going up. This will be a fairly long blog post as I want to give you a comprehensive view around why I think short-term rates are better.
In reality – what is a fixed rate?
There is no debate that eventually interest rates will go up – we are at the bottom of an interest rate cycle. With a fixed rate you pay a premium now for a set period of certainty. However, you will not avoid higher fixed rates altogether. In three to five years’ time your fixed rate will mature and rates will be significantly higher than today. If you are simply trying to avoid higher rates later on – ask yourself: “Will my fixed rate achieve this or simply delay the inevitable?”
Whether you take a three-year fixed rate or three consecutive one-year rates, in three years you will be at the same point – with a maturing fixed rate. So the question is what strategy saves you the most interest over those three years? (I think the one year!)
Short-term rates will increase … When the economy recovers
Most reputable commentators think that a true economic recovery will be a slow and drawn-out process. Within that there will be some ups and downs. There is talk of a recovery already, but fundamentally I can’t see it in the area that really matters: business growth.
Why is this important? Mostly because a lack of business investment and growth supports my view that rates may jump around a bit but will fundamentally take a while to increase. Rates will be flat to increasing over the next three to five years, maybe longer. I certainly do not expect to see short-term rates up over 8% for a very, very long time.
Where I do agree with other commentators and bloggers is that there is a frustrating structural imbalance in our economy. There is a risk that low mortgage rates just send us down the same path as before – throwing money at property. However, I don’t think this will happen this time around. Banks are still highly risk-averse and especially averse to property investors. And, whilst finance companies are temporarily making a comeback, this will be short-lived, with the Government guarantee ending next year.
Can I afford higher mortgage rates?
Rather than take a long-term fixed rate, another way to build certainty is to set your mortgage repayments based on an interest rate of 8.00% irrespective of what fixed rate term you choose. In other words, simply focus on paying your mortgage off as fast as possible. By starting with higher repayments than necessary, you can keep your repayments the same no matter what happens to interest rates. When rates are below 8% you pay your mortgage off faster. When rates are over 8% we move you on to interest only.
With a short-term mortgage rate you will pay less interest
Given that fixed rates only provide limited certainty, and that as outlined above there are other ways of building certainty, the big question is: “Under which option will I pay less interest?” This depends on (1) how quickly you are paying off your mortgage and (2) how quickly mortgage rates increase.
Using some cool mathematics we can calculate how quickly rates need to increase for the five-year fixed rate to be considered good value. These rates are shown below as implied future rates (grey). We have shown these against my view of how future rates will track (orange.)
- NZ Mortgage Rate Forecast
If rates pan out as I expect, then you’ll pay up to 20% less interest using short-term rates. On a $400,000 mortgage that equates to an extra $32,000 off your mortgage in five years’ time. Based on my view of interest rates I consider the fair value for a five-year fixed rate to be 6.95%. (Back in February, when it was below this level, we recommended fixing for five years but have since been calling shorter-term fixed as offering better value.)
Even if rates increase faster than I expect (green scenario) you’ll still be better off using short-term rates paying up to 8% less interest over five years.
Download free mortgage advice / tool
Download the following Excel spreadsheet and try out your mortgage. The spreadsheet show you your total interest costs over time depending on what fixed mortgage rates you choose. All we ask in return is that you share this blog post with all of your friends so that they can benefit from some free mortgage advice. To make sharing easier you can use the “Share This Post” button at the bottom of the page.
Click the link below to download the Rate Forecast Model (Excel):
Conclusion
- We recommend using short-term mortgage rates and to focus on repaying your mortgage as fast as possible. Set your repayments a bit higher than you need to and by doing so think of your mortgage as “fixed for life.”
- Split your mortgage into multiple fixed rates (using a selection of the floating, six-month, one-year and 18-month terms.) This simply means that your whole mortgage does not mature at the same time.
- Don’t do too many splits because if you are with Westpac, ASB, BNZ or Kiwibank you may be charged a fee when your fixed rate matures, ranging from $100 with Kiwibank to $250 with Westpac. (Thumbs up to ANZ and National Bank who do not currently charge these fees.)
