Brother in Law's guide: Mortgage rates have bottomed, so fixers should fix soon (Updated June 11)

By Bernard Hickey Here's the short version: Mortgage rates have bottomed out. The Reserve Bank of New Zealand (RBNZ) ended six months of record rate cutting on June 11 by leaving the Official Cash Rate on hold at 2.5%. It has called for banks to further reduce their short term mortgage rates, but this call is likely to be ignored, even though the RBNZ has reassured them that the OCR will be on hold until late next year. Banks are increasing their longer term mortgage rates (3, 4 and 5 years), but are generally holding their floating, 6 month, one year and two year rates. Those wanting the certainty of a longer term mortgage to lock down their costs should fix now because the waves of government borrowing hitting our market and credit markets globally will push up longer term interest rates for years to come. Those wanting the absolute lowest rate for the immediate future can probably afford to stay fixed at 6 months to 12 months for another 6-12 months because the economy will probably stay in recession until late this year or early next year and the Reserve Bank has 'promised' to keep the OCR at or below 2.5% until late 2010. But the risk is that longer fixed rates will have risen sharply by the time a borrower tries to lock in a longer term rate. If my brother in law was asking, I'd say lock in for a couple of years now because rates are rising. It's not urgent, but anyone borrowing should know that the long term average mortgage rate in New Zealand is around 8% and rates will revert there at some point from around 6% for 1 to 2 year rates now. If my brother in law was still sceptical, I would say have it both ways by floating half and fixing half. Here's the longer version:

The Reserve Bank held the OCR at 2.5% on June 11 as most expected. It decided there were enough 'green shoots' emerging in the local and global economies to hold fire for now, but warned the recovery would be slow and fragile and it could cut the OCR again. It reassured again that it would keep the OCR at or below 2.5% until late next year. Governor Alan Bollard called on the local banks to cut their short term mortgage rates further, saying he had given plenty of assurances for now and they had a role to help boost the economy. But the banks ignored his calls after the April 30 rate cut and are focused on fighting for term deposits with higher interest rates. I'd be very surprised if they cut after this latest piece of jawboning. The end result of all this is that actual retail interest rates are either flat for short terms or rising for longer terms. So what does all this mean for my brother in law? It's worth looking at whether mortgage borrowers who are rolling over in the next couple of months should float or fix, and if they fix, for what period. This question of whether to fix or float and how long to fix is actually quite a complex question. It requires a view on where the OCR is heading, what is happening to wholesale interest rates and what profit margins the banks may choose to impose on top of these wholesale rates. Essentially, it requires a view on the likely state of the global and New Zealand economies, along with an idea of the stability and profitability of the banking system. Individuals will also have their own situations to consider. If a lump sum is expected in the near future such as a bonus, redundancy payment or inheritance, it can make sense to go variable rather than fixed, even if the rate is higher because debt can be paid down early to save money. Or it may make sense to fix even though the cost is higher because a borrower wants certainty about their outgoings. Everyone's situation is different. This analysis is aimed at a "˜typical' mortgage borrower who wants to find the lowest mortgage servicing costs for the foreseeable future. I fit into that category, having a sizeable mortgage over the house I live in, so this counts as an analysis aimed at myself and for my proverbial "˜brothers-in-law.' So I'll call it the brother-in-law's guide. Now the caveats are out of the way, let's start. OCR may trough at 2%, but it won't be passed on The OCR may be cut to as low as 2% by the September 10 MPS and OCR announcement. The Reserve Bank has indicated it is likely to hold the OCR at 2.5% or lower until late 2010 and I think it will stick to that because we are in a recession that could last until early 2010 and any recovery will be tentative and slow. But banks are unable and unwilling to pass on the extra 50 bps of rate cuts because their international funding costs are high and they are having to compete hard for local deposits. Six month term deposit rates have actually risen around 50 basis points so far this year. That means variable mortgage rates are unlikely to drop much below 6% and six month and 1 year rates are likely to be stable around 5.5% until late 2009 and possibly into early 2010. But 3, 4 and 5 year mortgage rates have already risen 100-200 basis points since February and could easily rise by the same amount again by the middle of next year. Two year mortgage rates have also risen, but only slightly. They could hold for another six months, but that becomes less likely as we get closer to the end of the year. If my brother in law wanted the certainty of a longer term mortgage to lock down his costs, he should fix now because the waves of government borrowing hitting our market and credit markets globally will push up longer term interest rates for years to come. Having it both ways Anyone who values the certainty of a longer term fixed rate is probably safe to fix now, comfortable in the knowledge that these rates have fallen about as far as they can. Variable mortgage rates (see all the rates here) have probably fallen as far as they are going to drop, but it is possible they could nudge a tad lower. Those believing rates could fall further could benefit from some of this by fixing half their mortgage and floating the other half. My gut feel is that the global economy is in for a deep recession through 2009 that could easily extend into 2010 in a milder form. New Zealand's recession could easily extend through until early 2010, with the earliest signs of a recovery being accompanied in late 2010 by an increase in the OCR. Having half in 18 month to 2 year fixed allows some flexibility about when to fixer longer term in anticipation of higher long term rates. My gut feel is, however, that actual rates have stopped falling so there is no loss in fixing longer term. It may already be too late to fix very long term because 5 year mortgage rates have already risen over 8% in recent days from as low as 6% in late January.