Mortgage borrowing strategy

Monday 27 January, 2009

Mortgage rates continue to fall, particularly for longer maturities, which have “caught up” with earlier falls in short-term fixed rates. As a result, fixed rates are now close to 7 percent for terms ranging from 6 months to 5 years. As the RBNZ cuts the OCR further, we expect to see mortgage rates fall further. However, we need to be mindful of what’s priced in already, widening margins and the likelihood that long-term rates don’t fall as far as short-term rates.

Our view

Mortgage interest rates are likely to gradually drift lower as the easing cycle continues. We also expect to see the floating rate fall so that it is either equal to, or below all fixed rates, with the exception of the 6 month rate – a situation that hasn’t prevailed for almost 9 years. Generally speaking, this is good news for borrowers, and one of the few positives that comes from an economic slowdown. However, there are three limiting factors:

1. these expectations are already partly “factored in”. This means that we need to see the general flow of news and data deteriorate even more markedly for interest rates to move even lower. We think this is likely, but the proof will be in the pudding, so to speak;

2. margins are under pressure. Wider wholesale funding margins means wider mortgage margins. As has been the case for some time now, falling market (or “swap”) interest rates will not be reflected point for point in mortgage rates;

3. the tendency for short-term interest rates to fall further than longterm rates as we near the end of the easing cycle. This means that when the time comes to extend the length of your fixed mortgage, you should expect to pay a higher rate. This is almost inevitable.

Themes we favour in the current environment

As interest rates move lower, it will naturally be tempting to fix your mortgage at a rate that seems attractive relative to recent history. Getting this right clearly depends on getting the timing right, and is complicated by the third point raised above. That is, as the general level of interest rates falls, it will cost more to fix for a longer period. While this isn’t the case at the moment, the gap between short- (i.e. < 2yrs) and long-term (3yrs+) wholesale interest rates is widening, and this will soon be reflected in mortgage rates. This has the effect of discouraging borrowers for opting for the more costly longer terms – however at some stage, it will pay to do so. Historical experience (here and overseas) shows that long-term rates don’t tend to fall as far as short-term rates. At some stage then, borrowers may wish to consider taking a step up into a more expensive longer-term fixed rate if they would like longer-term certainty. However, we don’t believe that time has come yet, and we favour floating, or short-term fixed rates like the 6 month. The obvious problem of fixing for longer (even for just 1-2 years) now is that you will be tied in, and won’t be in a position to lengthen should long-term mortgage rates bottom out sooner rather than later. By contrast, by remaining floating, or fixing for just 6 months, you will have the benefit of being able to review the situation later in the year.

Source: National Bank, Property Focus