What’s next for mortgage rates?
Over the past couple of weeks banks have raised their fixed lending mortgage interest rates while at the same time cutting floating interest rates.
Why these divergent moves? The cut in floating rates cannot be attributed to falling bank funding costs. In fact the exact opposite is happening.
Early last year when the Reserve Bank's official cash rate was at 8.25 percent 150 day term deposit rates were lower near 7 percent.
Now, with a 2.5 percent cash rate term deposit rates approaching six months are above 4.5 percent.
Perhaps more importantly, whereas traditionally in NZ retail term deposit rates have sat below wholesale borrowing costs, now the opposite appears locked in with the likes of six month bank bill rates sitting currently near 2.8 percent.
We banks are trying to reduce our dependence on foreigners to fund the excess borrowing of Kiwis by lifting deposit rates. Just recently the strong desire to boost local funding has led to higher floating borrowing costs.
Yet while our floating borrowing costs have risen floating lending rates have declined. Why?
The answer is a change in where we banks fight for customers away from discounting fixed lending rates to discounting floating rates.
This seems counterintuitive because for years we have offered low margin fixed rate loans to try and lock customers in for a few years then market other products to them. But something important happened early this year.
In March billions of loans were suddenly switched from floating rates to at that time record low fixed rates - basically after I wrote in my Weekly Overview publication under the section "If I were A Borrower What Would I do" just two words - Fix Now.
So many people acted on that suggestion that we banks could not cover the loans by immediately borrowing fixed as we lent fixed.
The result was that we ended up borrowing at far higher rates than if conditions were normal.
Customers got great deals. We locked in absurdly low margins for years.
There have been fears that this switching event might happen again before the end of the year and we banks would again be scrambling to change floating rate funding to fixed for billions of dollars in just a few days.
It normally takes weeks. So the incentive for customers to leap into fixed from floating is being reduced. The bad news for borrowers is that fixed rates are being lifted (or more accurately, the old discounts are being removed.)
The good news is that floating rates have been cut.
Back in March people locked in seven year fixed home loan rates at 6.79 percent and five year rates at 6.49 percent. Those rates are now 8.99 percent and 8.6 percent respectively.
But floating rates are at four decade lows near 5.6 percent and probably won't rise until toward the middle of next year.
Personally speaking I am a strong advocate of fixing one's mortgage interest rates.
But the jump from floating to fixing has now become so large that one now may as well opt for a floating rate and hope that in two year's time world growth and inflation are not taking off.
What one should do is use the next 6-9 months to pay off as much principal as possible before the floating rate starts rising, and budget for the current rates rising at least 3 percent by early 2012.
Do not be caught out like the Americans who in 2003 stopped fixing their rates 30 years as their parents and grandparents had done and went floating at ridiculously low rates of 2 percent.
They were caught out when those rates shot to 6 percent come the middle of 2006 and the whole downward spiral of the US housing market and the world's credit markets got fully into swing.
Tony Alexander is chief economist at BNZ