Mother in law's guide to term deposits and mortgages

New Zealand's love affair with fixed rate mortgages may be about to end, while many savers are rediscovering their passion for finance companies. A few months ago I surveyed the market for term deposit rates and mortgages to see who had the best deals and whether to opt for long term or short term savings accounts and loans. So much has changed since then that it's worth revisiting this area, in particular the ideas that fixed mortgage rates will always be cheaper than variable rate mortgages and finance companies are too risky to invest in. So what's changed?

Firstly, the Reserve Bank has slashed the Official Cash Rate (OCR) from 8.25% to 6.5% in the last 3 months, including the unprecedented 1% cut on October 23. Most economists are saying it will be cut again to 6% on December 4. Secondly, the government announced plans on October 12 to guarantee deposits worth up to NZ$1 million in banks, building societies, finance companies and credit unions. The guarantee scheme hasn't been completely finalised, but is expected to last for at least two years. Finally, the economic news in the last month has been awful. Business confidence crashed, retail spending was weak, home construction slumped and new lending has dried up. Economists are now forecasting a longer and deeper recession and are rapidly cutting their forecasts of where the OCR will bottom out. Some are saying it could fall below 4% by the end of next year. JP Morgan is saying it could be cut to 3.25%. All these factors have transformed the equations for borrowers and savers. Here's my observations on the best options for borrowers and savers. One caveat first. As I said a few months ago, this is what I'd suggest my retired mother in law do with her savings and what I'd say to my sister in law if she needed to roll over her mortgage. This is not financial advice. Everyone is different and this is just what I'd say to these two relatives. But my insights are independent and rely on regular observations of what's happening to interest rates, the economy and financial institutions.  Term deposits (See all the rates here for call rates, for up to 1 year and over 1 year) The government's deposit guarantee changes the landscape utterly. Where once finance companies were a risky prospect with higher interest rates, they are now as safe as the government and offer higher interest rates. The likes of South Canterbury Finance, Marac Finance, Allied Nationwide and Fisher and Paykel Finance are all offering 9-10% from one to two years. They have all applied for the guarantee and are certain to receive it. Meanwhile, the banks are offering no more than 6.75%, but are in effect just as 'safe' as the finance companies. It makes sense to put savings with a finance company, but not for terms any longer than 18 months to 2 years because the guarantee is likely to be withdrawn or changed after that. I'd stick to the highest rated finance companies mentioned above. Getting money out of the government would not be easy or fast in the event of a collapse. Also move quickly. The finance companies are likely to drop their rates closer to the bank rates once they have filled their coffers and have run out of places to lend on the deposits, which is happening quickly. Mortgages (See all the mortgage rates here) Both fixed and variable rate mortgages have dropped and the gap is narrowing. Where once variable rates were as much as 3% higher than fixed rates, that gap is down to around 2% and falling. It's still cheaper to go with a fixed rate mortgage, particularly the 1 year rates being offered by many banks. But there is now a serious risk that a 2 year fixed rate taken out now would be higher than a variable rate being offered in the second year of the mortgage. The OCR is expected to drop to around 4-5% by the end of 2009. Given variable rates are typically around 3% above the OCR, this means variable mortgage rates could be around 7-8% by then. Currently Kiwibank and the big banks are offering around 7.9% for their one year rates and around 9.5% for their variable rates. It makes sense therefore to go for the 1 year rates and then aim to pick up the lower variable rate when the 1 year rate expires.