Banks are blaming higher mortgage rates on higher funding costs even with the OCR at historic lows. That’s a convenient half truth. There are three factors in play:
As I discussed in October last year, banks are under increasing profit pressure. Most of them went into a new financial year on 1 October so will be feeling the pinch. From experience, getting behind plan after the first quarter is rather uncomfortable. Hence, in the absence of balance sheet growth, banks are much more focused on absolute margins and hitting plan. Funding costs are high at least when it comes to term deposits which have been going up. That’s tough for the small local banks that have limited capital and rely on term deposits for funding. But term deposits are only part of the funding mix and I don’t recall savings account interest rates going up (and they won’t.)
Cash backs will largely disappear this year. Most of you will have received one at some point. For those that haven’t, banks have been paying borrowers cash incentives as part of taking out a new loan or refinancing. It was never sustainable and the amounts paid are decreasing. If you want to make the most of refinancing, then now is the best time to consider it. There are still cash backs to cover costs, some degree of competition, and there’s the benefit of locking in a low longer-term mortgage rate before they go up further.
One of the other factors in play that I’ve discussed for the past decade (and that nobody else discusses) is swap rates. These are the rates that banks use to fund fixed mortgage rates. Long term fixed rates go up and down the elevator. When a borrower fixes for 5 years the bank essentially matches that with an investor wanting a 5-year fixed rate. The problem is – there are not many investors out that far, so when demand for long term fixed rates spikes, often the swap rates will shoot up quickly. Borrowers see the rates shooting up, causing them to panic. More rush in to fix and that pushes rates higher still. Whenever long term fixed rates go up they tend to jump rapidly before settling down and often overshoot. That’s what we’re currently seeing. Rates start to settle when longer-term fixed rates look unattractive. The differential between the 2-year fixed rate and the 5-year rate is key. When it gets close to 1% borrowers will opt for the lower short term rate. Borrowers can seldom bring themselves to pay too much over the lowest rate on offer. For the most part, the recent spike in mortgage rates will stop and borrowers will trend back towards 1 and 2-year rates. The 2-year rate itself has jumped a fair bit already from around 4.19% in November to 4.79% now. Advertised 5-year fixed rates are sitting around 5.60%. With the steepness in the mortgage curve, banks will be hoping borrowers jump back into floating rates where they have much higher margins. Interestingly, banks have taken the opportunity to increase their floating rates (by 15 basis points) even without the OCR changing. There is roughly $80 billion of floating mortgages so 0.15% injects $120m of annualised revenue straight into their veins.
Best advertised rates
|Term||Floating||1 Year||2 Year||3 Year||5 Year|
I don’t recall seeing the gap between the best and worst lenders this big for some time. At Squirrel we have access to more lenders than any other broker, so if you’re in the market it’s well worth having a chat to one of the team about the best option for you. Forecasting rates The first thing to have a look at is the Reserve Bank OCR dates for 2017. These are the dates around which the media become transfixed on interest rates. The first one is coming up on 9th February. The MPS dates are the important announcements, as that’s when the Reserve Bank delivers a whole policy statement and sets the tone of the market. It’s a media circus, delivered live, with analysts pouring over every word.
|9 Feb 2017||OCR and MPS|
|23 Mar 2017||OCR|
|11 May 2017||OCR and MPS|
|22 June 2017||OCR|
|10 Aug 2017||OCR and MPS|
|28 Sep 2017||OCR|
|9 Nov 2017||OCR and MPS|
In November 2016 the RBNZ forecast no change in the OCR over its forecast period through to the end of 2019. In February we’ll get the opportunity to see if that view has changed. I doubt it. The RBNZ induced credit contraction is doing its job and there’s no visible inflation on the horizon yet. The Official Cash Rate is going to stay low and that should anchor short term fixed rates not withstanding some of the profit pressure influencing mortgage rates. The current best rates are just a point in time. What’s really important is the amount of interest you pay over time. With shorter term fixed rates they’ll come off sooner and reprice sooner. If rates are going up, you get a lower rate now and a higher rate later on. The way to understand fixed rates over time is to look at the implied forward rates. WTF is an implied rate, right! These are the break-even rates when fixing for different terms. For example, if I fix now at 4.43% for 1 year what rate would I have to pay in a year’s time to be indifferent between rolling a 1-year fixed rate or fixing now for 2 years at 4.99%? The answer is 5.55%. The next question is will the 1-year fixed rate be 5.55% in 1 year? So my view on this is that the 1-year rate will track lower and offer better value for money. (Essentially the difference between 1 year and 5 year fixed rates is too high.)
|Now||in 1 Year||in 2 Years||in 3 Years||in 4 Years|
|1 Year Implied||4.43%||5.55%||5.44%||6.50%||6.50%|
This isn’t the only thing to think about and everyone’s situation will be different. It’s important to discuss your strategy and circumstances with an adviser. Even with my view above, I don’t think rates will necessarily go up this far but it’s prudent to have a bias towards rising rates. I wouldn’t be surprised to see volatility keep rates bouncing around at historically low rates centered around 5%. The Reserve Bank has no pressing need to increase rates. Longer term fixed rates look attractive (from a risk perspective) when they are below 5.00%, which we can still do for 3-year fixed with some lenders.