What's up with mortgage rates

Arrow signs pointing in opposite directions

By the time this is published in NZ Property Magazine in March, mortgage rates may have already increased.  To get my view on a timelier basis consider “liking” us on Facebook or follow our blog.

Let's start with wholesale interest rates, technically referred to as swap rates. Swap rates have been increasing since December. The 1-year swap rate has gone from 2.54% on 1th December to 2.82% on the 15th February, an increase of 0.28%. The 3-year rate has gone from 2.72% to 3.16%, an increase of 0.44%. Over the same timeframe advertised rates haven’t moved. This highlights how mortgage rates have become meaningless when it comes to understanding the nuances of what is really going on. I’d imagine very few borrowers are actually paying carded rates, with most negotiating large discounts. In 2010 lenders were targeting a margin of 2.40% over swap rates. Over the course of 2011 and 2012 this increased to 2.70%.

A lack of transparency around funding costs, and a lack of overt competition, has helped margins and profits increase. We predicted back in 2009 and 2010 and 2011 that these higher profit levels wouldn’t last. It’s just taken a bit longer to manifest! Essentially we have lenders competing for market share in a low growth environment with a challenger brand thrown into the mix (Kiwi Bank) and a “perceived” vulnerable beast in the merger of ANZ and National Bank. All lenders are now focused on market share and in recent months competition has become more overt. Lenders are happily refinancing each other’s customers. Based on the 1-year swap rate, the advertised rate should have been around 5.25% in December (which it was) and 5.50% now. Instead, the advertised rate is currently 5.25% and lenders have been offering special rates as low as 4.89%. The bank margin on a 1-year fixed rate has fallen about 0.55%. At the same time other promotional costs have been increasing.

New borrowers have been enticed by free insurances, free tablets and of course cash contributions. So whilst wholesale rates have been increasing, heightened competition has kept the lid on mortgage rates. The second more recent trend is the use of long-term special rates. I’ve heard all sorts of uninformed, plain stupid logic around why lenders are dropping long-term rates. In reality lenders tend to only compete on 1 or 2 fixed terms. This is usually across the most popular terms, of which the most popular is the 2-year fixed rate. Margins have become much tighter on these terms. In contrast less competition on long-terms has meant much higher margins. The quandary with long-term fixed rates is that there is a lot less funding available. As soon as borrowers rush in to fix, the wholesale rates will rapidly increase. Long-term specials don’t last long. Currently the margin on the 1-year term (based on a market rate of 4.95%) is 2.20%. The 5-year swap rate is 3.50%.  Thus, based on an equivalent margin, the 5-year mortgage rate should be around 5.70%, which incidentally is where Westpac is currently pricing its 5-year special. Of course a margin of 2.20% is well below where lenders would like it. 5.70% for 5-years is without question an exceptional long-term fixed rate. It wont last long, it can’t last long. As soon as people rush into fix, it will push wholesale rates higher. With these sorts of offers you have to get in fairly quickly.

The Big Picture and Rates

My view is that the world still has another 10 years of pain ahead and this will keep rates generally low. We are waterlogged with debt and we have the biggest group of consumers in history starting to transition into retirement. Although Auckland house prices are increasing it is a supply side issue that will eventually resolve itself. Increasing retail sales is confidence driven. It is fickle and my view is that the underlying trend will remain weak. In my opinion we are going to be in a low growth environment for a long time yet, and that means low interest rates. There will be blips along the way where rates track higher, and blips where rates track lower. Personally I’m happy to stick with short-term rates. If you have weak surplus income, I’d strongly consider locking some of it away for 5-years.