Bernard Hickey says you should use the 'savings' from lower mortgage interest rates to repay your loan faster. Your view?

By Bernard Hickey

Last week I recommended readers put down their coffee and croissants and ring their banker to demand a lower floating mortgage rate.

Many did just that and I've been swamped with tweets and emails from happy readers saying it worked.

Many report getting their floating rates reduced from 5.75% to around 5.3% simply by threatening to leave.

So what to do now?

Firstly, buy yourself another fresh coffee and croissant! But I reckon that should be the extent of the celebration.

Certainly avoid a conversation with your banker that involves taking on yet more debt.

I should have warned readers that that may have been one of the unfortunate side effects of ringing your banker. Any well-trained bank customer service person is a master of the 'up-sell' and sees any 'touch point' with a customer as an opportunity to offer yet more debt.

It may be tempting for those who now seem to have a bit more financial headroom.

The prospect of even lower floating mortgage rates, if, as markets expect, the Reserve Bank cuts the Official Cash Rate later this year, appears to make a bigger mortgage even more affordable.

Those who have stayed floating will get the advantage if the OCR is cut.

But it's worth thinking more than twice before loading up on yet more debt or using the lower interest rate to reduce your payments.

New Zealanders have started reducing their mortgage debt load, albeit barely. Reserve Bank figures show household debt, which is 94% mortgage debt, is still 141.7% of disposable income. That's down from a peak of 153.8% in the September quarter of 2008, but  well above the more 'normal' 100% level seen in 1999 before the housing boom.

The interest costs on New Zealand's households is however down substantially at 9.3% of disposable income (about where it was in 1999) from a high of 14.4% in that September quarter of 2008. That's because average mortgage interest rates have dropped from over 9% to around 6%.

This is the crux of the decision to make around whether to take on more debt or repay debt faster: how lucky do you feel about interest rates?

My rule of thumb is: could your household finances cope if you or your partner lost a job or got pregnant when interest rates were at 10%?

That might prove an uncomfortable question for most readers as they chomp on their celebratory croissants?

Many people borrowing right now, particularly those first home buyers just entering the market, would scoff at the thought of having to pay 10%. It seems unthinkable in an era of perma-crisis on financial markets and as economies struggle to grow again.

But many readers will remember those painful times in early 2008 when floating and fixed rates were around 10%. Real old-timers will point to 20% plus rates in mid 1987.

Most doubt those levels will be seen again in our lifetimes, but 10% is a possibility if the Reserve Bank is forced to hike hard to control inflation. Most economists are forecasting a rise in the Official Cash Rate to around 4% within a couple of years, which would imply floating mortgage rates of around 7%. That is just below the long term average of around 8% and the very least borrowers should plan for.

The other reason to stick to the croissant and avoid the champagne is these low rates are low for a reason: the global economy is in trouble and there's a real chance of higher unemployment here.

That increases the risk a borrower may lose their job or see their incomes reduced. Or (heaven forbid) house prices fall.

I reckon the simplest and safest thing to do after finishing the croissant is to keep the payments at the previous 5.75% rate and repay the mortgage faster.

For example,  anyone with a NZ$500,000 mortgage who chose to keep repaying a 5.3% floating mortgage at their old 5.75% repayment rate would repay their mortgage 15 months early and save NZ$52,425 over the life of a mortgage.

That's an awful lot of croissants and champagne, and a lot fewer sleepless nights.

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You can do the calculations here » with our clever mortgage calculator.

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