Official confirmation! Mortgage rates will remain at historic lows for the long term. How can you benefit?

Treasury: interest rates expected to stay low for the long term

As the economy gradually recovers, many economists predict that interest rates will begin rising in the short to medium term.

ASB economists say improving economic conditions and rising long-term interest rates worldwide will also put upward pressure on New Zealand rates, particularly longer-term fixed mortgage rates.

A Westpac report went further, specifying the timing and size of the increase: “We expect two-year fixed rates to begin rising later this year, reaching around 4% by the end of 2022 and 4.5% by the end of 2023.”

Some economists take the opposite view. Independent economist Tony Alexander, for example, believes the Reserve Bank of New Zealand will be “quite cautious” about interest rate rises, “because even an increase of just 1% would have a considerable impact on the market”. Overall, however, industry voices arguing that rates will not remain low far outnumber those taking the opposite position.

Now, an official voice has finally delivered the verdict!

In a recent interview with Interest.co.nz, New Zealand Treasury Secretary Caralee McLiesh said: “We know interest rates are low now and are expected to remain very low.” Low rates benefit borrowers, asset owners and people on the margins of the labour market, while disadvantaging savers and those trying to buy assets such as homes.

McLiesh also noted that low interest rates were not the only reason for the housing boom: “At the start of the pandemic, almost all forecasters expected house prices and other asset prices, including government bonds, to fall. So we have also been surprised by the extent to which interest rates have driven house prices up, but other factors have contributed too.”

 

Three reasons why continued low interest rates are an inevitable trend 

In fact, a closer analysis of the underlying reasons for New Zealand's falling mortgage rates over nearly the past year reveals that rates remaining low for a long time to come is an inevitable trend.

From the perspective of government macroeconomic management, low interest rates are a global trend. Countries such as Switzerland and Japan entered the negative-interest-rate era some time ago, while central bank benchmark rates in many other developed countries remain below 0.25%. The most important reason for this is to stimulate domestic demand and restore economic activity.

From an economic perspective, we believe mortgage rates will remain low because commercial banks' funding costs continue to fall. The Official Cash Rate, OCR, low bank deposit rates and the Funding for Lending Programme, FLP all help reduce commercial banks' costs. Persistently low rates have also lowered savers' expectations of interest returns. Together with forecasts of continued low rates, this encourages some conservative investors to put their money into relatively safe bank term deposits, giving commercial banks more cheap funding.

From a free-market perspective, intense competition between commercial banks means that when one bank lowers its rates, others are very likely to follow. This competitive restraint makes substantial rate increases difficult.

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Three key influences: interest rates are not the only consideration 

Interest is the cost of borrowing, but people seeking a loan must first consider whether they can borrow and how much, then how to secure a better rate. Beyond interest rates, three other important factors affect lending:

• Loan-to-value ratio, LVR

The loan-to-value ratio, commonly known as LVR, has the most direct effect on borrowing. For investment property buyers in particular, its importance far outweighs the impact of interest rates. Leaving income aside, if a buyer needs to release equity from an existing home to buy another investment property, deposit requirements of 20% versus 40% could mean the difference between investing in one property and two.

For first-home buyers, a lower deposit requirement can also help them purchase an affordable home sooner. Notably, commercial banks impose various restrictions and additional costs when approving loans for owner-occupiers with deposits below 20%.

• Mortgage affordability requirements(Mortgage affordability requirement)

Today, each commercial bank has its own income requirements for servicing a given total loan amount, known as servicing ability. As long-term mortgages run for 30 years, banks generally use a higher “test rate” to calculate borrowers' repayment capacity, allowing for inflation, economic fluctuations and living costs. For example, the current rate at the four major banks is 2.29%, but many banks use test rates ranging from 5.8% to 6.45%.

Some banks go further, increasing their standard living-cost allowance according to an applicant's income as part of responsible lending. A higher living-cost allowance reduces the corresponding loan amount.

• Debt-to-income ratio, DTI

As the name suggests, a debt-to-income ratio limits the total lending a bank approves in relation to the borrower's total income. Beyond the affordability requirements discussed above, some commercial banks have already introduced DTI measures. For example, if a bank sets its DTI at 7.2 and your total annual income is NZ$100,000, its total lending to you cannot exceed NZ$72,000. If more banks introduce this restriction, applicants' total borrowing capacity will be substantially reduced.

  

Three areas to consider: the best option is the one that suits you

Many readers will be keen to know how to secure a loan smoothly and obtain the lowest possible mortgage rate in an era of low rates, fierce bank competition and frequent rate changes. The following three suggestions come from experienced professionals with more than a decade in the lending industry and are worth reading carefully before preparing a loan application:

First, keep watching interest rate movements：

There are many banks in the market. Beyond the familiar four major banks and Kiwibank, numerous others are available.

Some banks advertise infrequently but actually offer better rates. Rate cuts also tend to start with one bank, followed gradually by others. With rates changing frequently recently, there may be a lag before competitors follow.

Customers seeking low rates therefore need to keep monitoring rate movements or seek help from an experienced lending manager.

Second, consider your loan structure：

Interest rates are the most obvious way to reduce borrowing costs, but many people do not realise that loan structure is also too important to overlook.

Different loan structures can produce very different results depending on the borrower's income structure and the loan's purpose. For an investment property loan held at the same bank as an owner-occupied home loan, for example, splitting the loans and maximising the proportion allocated to the investment property can first help save tax. Choosing interest-only repayments can then reduce repayment pressure.

There are also many techniques for customers with different income structures：For example, customers with substantial cash flowing in and out, or with savings, can use a revolving credit or offset account to achieve an interest rate of 0 on part of their loan.

The real challenge is often choosing the best combination for each person's particular income and borrowing purposes. This is especially important for customers with multiple properties and complex borrowing needs.

Banks offer a wide variety of mortgage products with many differences, and finding the right combination often requires professional help.

Third, consider the cost of your time:

Time is money, and this is entirely compatible with shopping around, particularly when arranging a loan. The key to combining the two effectively is to have a professional mortgage adviser team handle your borrowing.

 

About the expert

York Zhang (Zhang Yong) 

Chairman, Plaxo Mortgages

In 2006, York Zhang (Zhang Yong) founded Plaxo Mortgages to provide the Chinese community with lending across categories including homes, construction, businesses, land development, vehicles and heavy equipment. Combining professional mortgage advisory knowledge with his personal experience of life in New Zealand, York Zhang hopes to use Plaxo Mortgages to introduce more products suited to the Chinese community's circumstances and needs, train more outstanding mortgage advisers and release more capital from clients' assets for reinvestment.