Mortgage borrowing strategy

Monday 27 July, 2009

While the housing market is recovering, it is off remarkable lows, and in itself is insufficient to alter our favoured borrowing strategy. We continue to favour being patient and taking advantage of low six month rates.

Our view

Aggressive competition for deposits is keeping pressure on borrowing rates. Borrowers need to appreciate the structural aspect to this story. With the RBNZ “telling” (and changing liquidity policy as such) banks to get more term funding in place (75 percent needs to be greater than one year), there will be two broad consequences. First, competition for deposits will remain intense, and particularly for term funding. This will keep the curve steep. If depositors are being rewarded, then, of course, borrowers have to pay. Second, this will remove (eliminate) the temptation for banks to fund aggressive demand for credit by issuing short-term debt, as was the case during the previous upswing. Reduced fuelling of the housing market via aggressive credit demand (and supply) should reduce the need to raise the OCR as aggressively over the next cycle. Collectively, these are key structural issues that impact heavily as we weigh up the relative attractiveness of different borrowing rates.

In terms of the broader economy, improvements in the housing market is leading to some speculation that the RBNZ could be raising rates in early 2010. This is supported by the historical experience that shows relatively short windows between the last cut and the first hike.

While we acknowledge the pick-up in the housing market and speculation of a shortage, we are mindful of the wider picture. The unemployment rate is rising, the global scene fragile, lower dairy payouts have yet to hit the rural areas, and there is no shortage of housing (see page 7). We continue to concur with the RBNZ in terms of their outlook for the economy, where they note, “it is likely to be some time before the recovery becomes self sustaining and monetary policy support can be withdrawn”.

In this environment, and coupled with intense political pressure that is being placed on the financial services industry, we maintain our bias towards short-term rates, and at this juncture the six month rate in particular.

Our breakeven table (refer our May edition for a full description) is presented below. All breakeven rates are higher than current rates, so the decision for borrowers is really about making the most of near-term cash advantages, whilst remaining mindful of not giving it all back (and then some) a few years down the track. At some stage there will be the odd year where you end up paying more. But what the table shows is that short-term rates would need to rise very aggressively for you to lose on average. We struggle to see this given the economic backdrop and regulatory changes.

Source: National Bank, Property Focus