The big debate: is fixing your mortgage for 3–5 years still worthwhile in an era of high interest rates?

‘If someone fixed for a year last May at around 2%, in a few months, when their term ends, they will face high rates of 4% to 4.5%. That is quite a change.’ This will be a headwind for the housing market and the wider national economy, as households are forced to divert more of their spending towards repaying mortgage debt.

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As we enter 2022, it is clear that homeowners need to prepare for higher mortgage rates. In fact, the signs have been there for some time. The latest Reserve Bank of New Zealand data (S33) shows that many borrowers have already adjusted by fixing their mortgage rates for longer terms. However, they remain a minority.

During 2022, as much as NZ$151,000,000,000 is expected to be exposed to rising interest rates, and that is for owner-occupiers alone. Investors have a further NZ$60,200,000,000 in mortgages facing rising rates this year, alongside NZ$3,900,000,000 in mortgage lending used for business borrowing that faces the same risk. This means a total of NZ$215,000,000,000 in loans will have to confront sharply higher interest rates in 2022.

Every 25-basis-point rise in interest rates adds NZ$537,000,000 to annual interest costs. If there are two or three rises of 25 basis points this year, mortgage borrowers could face an additional burden of up to NZ$800,000,000. Banks have been working to ensure that their customers, particularly their newest borrowers, undergo sufficient stress testing so that all borrowers can cope with interest rate increases exceeding 75 basis points. In turn, however, that NZ$800,000,000 will no longer be available for spending from borrowing households' disposable income. Although this additional NZ$800,000,000 is small compared with annual retail spending of more than NZ$107,000,000,000, changes in household spending behaviour as disposable incomes fall will have a major impact on New Zealand's economy.

Experts predict that, as mortgage rates trend upwards this year, more borrowers will lock in rates for longer terms. At the start of 2021, 73% of household fixed-rate mortgages were fixed for one year, whereas by the end of 2021, fewer than 60% of borrowers chose a one-year fixed term. This is a major shift, with many people recognising the rise in interest rates and deciding to fix for longer. Interestingly, investors have made the same shift, but less enthusiastically than owner-occupiers, retaining more short-term loans.

The figures above show that many owner-occupiers are choosing 3-year terms, some are choosing 4 years, and many others are fixing for 5 years. Commercial banks have confirmed this trend. ASB recently said the number of its borrowers choosing 3–5-year fixed mortgages had increased. Around a fifth of its customers now have at least part of their mortgage on these longer-term rates, twice the proportion a year earlier. A bank spokeswoman said customers were seeking certainty over future interest payments as the Reserve Bank signalled further increases in the Official Cash Rate (OCR), which would have a flow-on effect on interest rates. The major banks currently offer one-year fixed rates of around 3.65% per annum, compared with 4.69% for three years. This means that, for a NZ$500,000 loan over 25 years, choosing the three-year rate rather than the one-year option means paying NZ$130 less in repayments each fortnight.

New Zealanders have traditionally favoured one- or two-year fixed rates, but economist Tony Alexander's monthly survey of mortgage brokers shows a sharp decline in borrowers' interest in short-term fixed rates. Entering 2022, people have found that banks' rates are no longer at historic lows, having risen by as much as 2% since last year. They remain ‘low’ by historical standards, but another 2% rise over the next year or two would return them to the ‘normal’ range of 6%. Fixing at today's low rates is less about seizing an unusual opportunity than a response to fear, as borrowers try to avoid a bigger shock to household spending.

Independent economist Tony Alexander says that, with annual inflation at 4.9%, people know interest rate rises are coming, so mortgage borrowers are trying to protect themselves. He predicts that one-year fixed mortgage rates will rise by 1–1.5% over the next year and a half. Of course, many of those who took advantage of historically low mortgage rates just above 2% fixed for only a year. Those who chose two-year fixed terms earlier will also face noticeable changes in monthly payments as interest rates rise in 2022. Experts suggest that, if your housing circumstances are stable, fixing for 3–5 years could be a good option. Fewer borrowers now use floating rates than at any other time in our history. In a rising interest rate environment, the share of home loans on floating rates may be pushed even lower.