Interest rates: To fix or not to fix?
Earlier this year, I was prompted to question the likelihood of the extensive mortgage interest rate increases that were predicted by a number of market analysts.
In the months since, the conversation has progressed and the focus has turned to whether it is time for households to consider locking in their fixed-term mortgages, ahead of a turning tide of potentially higher interest rate hikes.
In my view, it’s challenging to see the merit in fixing ones mortgage out any further than two years. Consider the scenario outlined in the table below, which details the current prevailing rates across two- and four-year fixed rate terms.
In order for a four-year fixed-term mortgage to be the better (and more cost effective) option – as compared with signing onto a two-year fixed term, and renewing in 2020 – the average two-year term interest rate over that period would need to be greater than the current four-year rate of 5.8 percent.
With the current two-year rate at 4.75 percent, this would require a 2.1 percent increase by 2020, to 6.84 percent. This would amount to approximately eight interest rate hikes from the Reserve Bank of New Zealand over that two year period.
As it stands today, the Reserve Bank isn’t forecasting an interest rate rise before the second quarter in 2019, so the chance of striking that 6.84 percent figure by 2020 is minimal – meaning, for now, the two-year fixed rate option is likely to cost less in the long run.
The interbank interest rate curve (the rate of interest charged on short-term loans between banks) will undoubtedly be highlighted by banks as a influencing factor behind their current four year fixed-term rates. The interbank rate has been considerably flatter than current fixed mortgage rates might suggest, however – and banks offering these rates are likely doing so with rather lofty expectations for future rate increases on the interbank front.
Banks may also point to growing offshore funding costs and the like as the rationale behind these increases, but credit growth has stalled recently and the funding task looks less onerous for the major banks than it has at other points of the business cycle.
I acknowledge that you can’t make all decisions based on spreadsheet calculations – especially when you factor in considerations such as certainty around borrowing costs and being able to work out household budgets with confidence.
There are many factors at play when making decisions around re-financing mortgage debt. I recommend thinking carefully before fixing for any longer than two years as the banks seem to have priced in a fair amount of the increases already - contrary to both the Reserve Bank's interest rate forecasts, let alone any back of the envelope calculations.
The views expressed in this article are those of Hobson Wealth Partners Limited, an NZX Firm and do not constitute advice. The disclosure statement for Hobson Wealth is available free of charge by contacting us on 0800 742 737. This article does not consider the objectives or situation of any particular investor. It should not be construed as a recommendation or solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. We recommend that you consider the appropriateness of the information in this article to your situation and obtain financial, legal and taxation advice before making any financial decision.
*Example of current average prevailing two and four year fixed mortgage rates
**6.84% would be the interest rate required when re-fixing for another two years in 2020 to achieve the same average cost as the current 4-year mortgage rate.
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