By Bernard Hickey
I have a brother in law who calls me up out of the blue sometimes to chew the fat on what to do about his mortgage.
He usually rings up around the time the Reserve Bank makes an announcement on the Official Cash Rate or when he's read something in the paper about 'now being the time to fix'.
Like most borrowers, my brother in law is on a floating mortgage now and is thinking about whether and when to fix, and who has best rate. I quite enjoy these chats because it forces me to think about how to make these decisions and to put it together into an accessible form.
Please don't take this as financial advice. Everyone has different situations and motivations. Many have different views about where interest rates are headed. Check out my companion piece called The Crystal Ball which includes the various economists' views on interest rates and whether to fix or float.
Most economists are saying the OCR is likely to rise from 2.5% to between 4.5-6.0% over the next 2-3 years. These expectations would make fixing for 2 years slightly cheaper than floating. Economists from BNZ and Westpac both say that now is the time to fix. ANZ National and ASB suggest floating for now.
After the July 28 statement on the OCR by the Reserve Bank, economists said they expected the bank to hike it by around 50 bps on September 15 and then leaving it at 3% until early next year while it assesses the impact and the global developments, before increasing it again next year. See more here in my article on the OCR decision on July 28.
But for what it's worth, here's my view for myself and my Brother in Law. We both have youngish families, tight weekly budgets and regular incomes. We're both looking for the cheapest deal for the forseeable future, which is about 18 months to 2 years in our cases. We like certainty, but we're not prepared to pay much for it. We want to repay our mortgages as quick as we can.
Stay floating - the short version
So here's what I say my brother in law should do with his NZ$400,000 mortgage with a floating rate of 5.75%:
The short version is I reckon he should stay floating, but should go back to his bank to threaten to leave and get a discount out of the bank. The banks have been offering floating rates as low as 5.60% through brokers to new borrowers and he should get the same. See all the advertised mortgage rates here.
I think a combination of slower global growth for years to come and the drive by many households to deleverage will keep the OCR from rising quickly or too high.
Stay floating - the long version
It's worth trying down the floating vs fixing decision into a few parts. Unlike in the past where fixing was obviously cheaper than floating both immediately and over the long term, now it's a bit more complicated.
The first question to ask is: where will the OCR go and when? The floating mortgage rate is linked much more tightly to the OCR than fixed rates. A decision about which is best depends on where you think the will go.
Market expectations are for a rise in the OCR from 2.5% now to around 4.25% by mid 2013 as the economy recovers and the Reserve Bank is forced to remove its stimulus from 2009 and 2010 by putting the OCR back up. Westpac's Dominick Stephens expects it to rise to 6% by the end of 2013 because he thinks the New Zealand economy will 'decouple' from a slowing global economy and the Christchurch rebuild will boost construction price inflation. See more on his views here.
My view is that households in the developed world are heavily indebted and are keen to repay debt in the years to come. Influential research from economists Carmen Reinhart and Kenneth Rogoff shows that high debt levels slow growth down as an economy deleverages. America, Europe, Australia and New Zealand all have indebted household sectors and/or governments.
Governments and central banks often choose or are forced to engaged in what is called 'Financial Repression' where they hold interest rates artificially low to ensure the economy doesn't go into a tailspin. See more here on Financial Repression here at the IMF and here at PIMCO.
They essentially decide that a little bit of inflation will help the economy dig its way out of debt and that savers will just have to bear the brunt.
You only have to look at what happened in Japan after its property bubble burst in the late 1980s. It has endured 20 years of near recession with near zero % interest rates. Every time the central bank moved to put up interest rates the economy slid back into recession, forcing the back to put rates down again.
That's what happened last year in New Zealand. The Reserve Bank put the OCR up from 2.5% to 3% and was forced to put it back down again on March 10, albeit after the shock of the February 22 earthquake.
We have a calculator at interest.co.nz that incorporates the market's expectations of the OCR and allows us to work out whether fixed or floating is cheaper.
The market is expecting the OCR to start rising again from September 15 and get to 4.25% by mid 2013. Given the current 2 year fixed rate of 6.4% and a floating rate of 5.75% now, my brother-in-law would actually be better off fixing to the tune of NZ$1,734 over those 2 years if the OCR rose as the market expects. Here's a link to the calculator I used to get these figures.
In my view the market expects too big a rise.
I think the OCR won't start rising until December and then various global downturns and a slow rebuild in Christchurch will allow the RBNZ to keep the OCR below 4% over the next couple of years. In that situation floating would be cheaper than fixing.
Here is what the economists say:
| Forecaster | First OCR move | Peak OCR | Fix or float? | House prices |
| RBNZ* | December quarter | 4.75% by Dec 2013 | Prefer you float | <2% pa |
| ANZ National | September 15 by 50 bps | 4% by end 2012 | Float for now | Listless |
| ASB | September 15 by 50 bps | 4.5% by Nov 2012 | Float for short term | 3.5% pa |
| BNZ | September 15 by 50 bps | 4.75% by Dec 2012 | Fix for 2-3 years | n/a |
| Westpac | September 15 by 25 bps | 6.0% by Dec 2013 | Fix | 0% in 2012 |
| HSBC | September 15 by 25 bps | 4.25% by Dec 2012 | n/a | n/a |
| Bernard Hickey | December 8 by 25 bps | 4.0% by Dec 2012 | Float | -5% |
* Forecasts implied from 90 day bill forecast track in June 9 Monetary Policy statement
(Updated July 28 after OCR statement; adds table on economists' views)
28 Comments
And up go the fixed rates http://www.interest.co.nz/borrowing/mortgages
Fixed in a day after your piece BH, thanks for the warning :)
What did the brother in law do?
FYI from a reader via email:
Bernard I charge big kick-back-fees for this type of information Do you really want to get your mortgage costs down? There is a very simple way. I know I've done it. Did it for 15 years. The banks won't tell you about it. They might even put a few obstacles in your way. But it can be done. It's called 90 day bills. Just keep rolling over every 90 days. Cost is Current 90 day bill rate is 3% + a line fee of 1%, or 1.5% The banks might have a minimum of $500,000 in which case both you and your brother-in-law could go co-joint borrowers. Check it out Banks are negotiable on the line fee and it's cheaper than floating mortgages. regardsYes, if you send an email to me at iconoklast@optusnet.com.au with a return email address I will advise my phone number and you can phone me, and I will explain.
Bernard - so the risks of the floating rate averaging lower than the fixed rates are zero ? So your brother in law has such a modest gearing that he can survive if your advice proves to be wrong?
Fixing is all about risk management and covering in case the market gets it wrong - in this case underestimating the rise.
Clearly you are a massive speculator, I'm not, and have taken some fixed on board - its called being prudent, and recognising a high risk world where the upside risks concerning money printing, peak oil, inflation and other factors defy accurate forecasting
"Bulls and bears make money, pigs get slaughtered"
So the rise for 2 years will be slow.....so brother will save for a while on floating now and then start to pay more if it rises.....or jump in now and pay some more up front....in either case in two years he will have to refix a the new, presumably higher rate or cop the floating....
We are not talking 10 or 15% inside two year here...we are talking 6% to 8% maybe 9%....v the current under 6%.....If he cant survive 9% he shouldnt be on that much debt frankly.
In terms of peak oil we saw three years ago that $147US killed the global economy, and the price fell to $35. I think $117US will do the same but maybe over a longer time span.....so it sits where it is for 12 or 18months and the global economy will be on life support....
So the downside is if it rises its moderate, against staying where it is or maybe even dropping as the oil price bites........Im going with this.....I think we have a flat 5 years ahead of us, if we are lucky....unlucky is Depression...and deflation and I think thats the most likely frankly.
regards
Stevn - you're drawing the same conclusion as always, that inflation will reflect growth, or the lack thereof - there's been periods when that's not been the case (70's being one of them), and this I suspect will be another one of them - you make a big assumption about a lack of Gobt or CB response to such a developing situation - hasn't the 2008-2011 respnse given you some clues ?
Eitherway, its a big bet to bet the whole house on it
"In my view the market expects too big a rise. I think the OCR won't start rising until December and then various global downturns and a slow rebuild in Christchurch will allow the RBNZ to keep the OCR below 4% over the next couple of years. In that situation floating would be cheaper than fixing."
Now its possible Bollard will have a bet each way and we might see a 25 basis point rise in September or October, in which case I wouldnt expect another rise until well into the next year....I think the rise will be very slow and cautious myself....This is how I see it playing out.....and this assumes we wont have a melt down....which I see as highly likely.
Interesting of course that no one see's hyper-inflation.....or maybe its like a depression, to bad to mention......
Oh and why say fix if the banks can make more money with floating? they have never struck me as honest before, and I dont believe them now....
regards
I broadly agree with Bernard, which has me a little concerned!
The rebuild in ChCh is not just going to be slower but smaller than people expect. So that emergency rate cut may last longer than the December prediction, but whatever anyone thinks will happen, it will be up in the air within a few months.
Who last August would have thought we would have an OCR of 2.5% by March 2011 and that the US might default within a year? (Everyone would have thought the Euro and Greece would have fallen over first).
Who knows? But personally I think things are much worse than anyone thinks, possibly 2008 again or possibly not, as I said, who knows?
@ HarryM and the reader re: 90-day bills
I feel like a mug bc I have quite a bit of business with ASB and they are always wanking at me and sucking up but they never provided this sort of advice. I am going to go and screw my account managers go-nads to the wall tomorrow!!!!!!!!!!!!!!!!
Unfortuantely that's how alot of business works these days, the loyal customers are the ones who are getting charged the most.
You think you are getting a good honest deal until you go somewhere else.........
Margins are and should be small these days, if you have been with a bank or any service provider for a long time it really does pay to get out there and see what is on offer!
"I broadly agree with Bernard, which has me a little concerned!" - I agree but then I look at it that BH had to get it right at some stage like all of us making economic predictions!!!!.
"But personally I think things are much worse than anyone thinks, possibly 2008 again or possibly not, as I said, who knows?"
I think 2008 was nothing - it hardly impacted me or most people I know - made us more circumspect and a bit more prudent with our spending but that was about all. This will be much more bc it will not disapear quickly and there will be no economic growth to pull us out, cheap energy and all that is exhausted - this will roll on for at least the next 10-15 years, who knows maybe longer. We are going to reach a "tipping point" in the next 12-18 months and if I had any advice I would say sell any property you may have and sit tight - if you want a house wait 2-3 years and you will be blown away by what you can get for your money but it will need to be your money not credit or a mortgage as in money from the bank.
They never once made life difficult for me. Because .. they are on the hook to you .. what are they going to do? .. immediately register the mortgages? .. begin foreclosure? .. what the heck for? .. if you have the 3% in your bank account (on rollover day) to pay the next interest charge plus their line fee it's much , much, much easier for them to just roll you over, take their costs out of your account and forget about you. Till next rollover. If your LVR starts to worry the bank they will put the pressure on you by increasing the line fee to 2% or 3% and keep going till you crack. If you dont have the funds in your account (to cover the interest) on the day and your LVR equity is good, you just rollover for a higher amount.
Well the RBNZ announcement this morning pretty much turns things on it's head. The market is now assuming the RB hikes by 25 or 50 in September. 50bps hikes takes floating to very close to 2 year in quick step, so any further hikes afterwards will take floating rate above the prevailing 2 year fixed rate. What price do you put on certainty now?
Obviously with the Banks prepared to discount their flaoting rates to keep customers they are enjoying interest rate margins well above budgeted predictions. There was no need for the RBNZ to increase rates in February - all the banks had to do was accept a reduced margin. Now the RBNZ is being dictated to by the Banks to raise rates so they can maintain these margins. Don't you have to feel sorry for Ralph Norris - resigning fron his position as head ofCBA Australia with an anuual salary last year of NZ$20million !!!
When you look at it...
Average NZer is sttruggling with weekly costs
American verging on default
The weorld i n general not all that flash economically
Australia admitting recently that apart from the mineral industry the rest of the countries economy is basically as bad as ours
Inflation may have been spiked by GST rise of October- NZ'ers have kept their hands in their pockets since then but everyday living costs have risen dramatically with the GST increase component adding to the costs.
All the above will lead to a large and fast increase in the OCR ... I think not!
Obviously with the Banks prepared to discount their flaoting rates to keep customers they are enjoying interest rate margins well above budgeted predictions. There was no need for the RBNZ to increase rates in February - all the banks had to do was accept a reduced margin. Now the RBNZ is being dictated to by the Banks to raise rates so they can maintain these margins. Don't you have to feel sorry for Ralph Norris - resigning fron his position as head ofCBA Australia with an anuual salary last year of NZ$20million !!!
When you look at it...
Average NZer is sttruggling with weekly costs
American verging on default
The weorld i n general not all that flash economically
Australia admitting recently that apart from the mineral industry the rest of the countries economy is basically as bad as ours
Inflation may have been spiked by GST rise of October- NZ'ers have kept their hands in their pockets since then but everyday living costs have risen dramatically with the GST increase component adding to the costs.
All the above will lead to a large and fast increase in the OCR ... I think not!
Obviously with the Banks prepared to discount their flaoting rates to keep customers they are enjoying interest rate margins well above budgeted predictions. There was no need for the RBNZ to increase rates in February - all the banks had to do was accept a reduced margin. Now the RBNZ is being dictated to by the Banks to raise rates so they can maintain these margins. Don't you have to feel sorry for Ralph Norris - resigning fron his position as head ofCBA Australia with an anuual salary last year of NZ$20million !!!
When you look at it...
Average NZer is sttruggling with weekly costs
American verging on default
The weorld i n general not all that flash economically
Australia admitting recently that apart from the mineral industry the rest of the countries economy is basically as bad as ours
Inflation may have been spiked by GST rise of October- NZ'ers have kept their hands in their pockets since then but everyday living costs have risen dramatically with the GST increase component adding to the costs.
All the above will lead to a large and fast increase in the OCR ... I think not!
Obviously with the Banks prepared to discount their flaoting rates to keep customers they are enjoying interest rate margins well above budgeted predictions. There was no need for the RBNZ to increase rates in February - all the banks had to do was accept a reduced margin. Now the RBNZ is being dictated to by the Banks to raise rates so they can maintain these margins. Don't you have to feel sorry for Ralph Norris - resigning fron his position as head ofCBA Australia with an anuual salary last year of NZ$20million !!!
When you look at it...
Average NZer is sttruggling with weekly costs
American verging on default
The weorld i n general not all that flash economically
Australia admitting recently that apart from the mineral industry the rest of the countries economy is basically as bad as ours
Inflation may have been spiked by GST rise of October- NZ'ers have kept their hands in their pockets since then but everyday living costs have risen dramatically with the GST increase component adding to the costs.
All the above will lead to a large and fast increase in the OCR ... I think not!
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