Banks keep raising short-term fixed mortgage rates. What is the best strategy for fixing?
NZ and ASB have announced successive increases to their fixed mortgage rates
Last week, ahead of the Matariki holiday, ANZ and ASB announced successive increases to their fixed mortgage rates, signalling the start of another round of fixed-rate increases among the major commercial banks. Kiwibank soon joined this wave of increases. By this Friday, the four major commercial banks other than Kiwibank had all raised their special one-year fixed rates to 5.35% p.a., while Kiwibank had raised its rate to 5.19% p.a. For two-year terms, ANZ and ASB were both offering 5.80% p.a., while Kiwibank, BNZ and Westpac were offering 5.69% p.a., 11 basis points lower. For three-year fixed terms, all the Australian-owned banks were offering 5.99% p.a., compared with Kiwibank's 5.89% p.a. Rates for four- and five-year terms were also broadly similar across the major banks. ANZ and ASB had the highest rates, at 6.85% p.a. and 6.95% p.a. respectively. Even after its increases, Kiwibank's four-year rate of 6.05% p.a. and five-year rate of 6.29% p.a. still looked relatively attractive and were the lowest in the market.
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YIJU has noted that, in this round of increases, the major banks have raised their short-term fixed rates by around 0.5% percentage points to 5.35% p.a. This is a considerable distance from 12 months ago, when banks began sharply increasing their 1-year rates from lows of around 2.19% p.a. It seems only a matter of time before 5-year fixed rates break through 7 per cent.
For homeowners, investors looking to refinance and first-home buyers, everyone must decide on a strategy for fixing the term and rate of their next mortgage, whether new or approaching the end of its current fixed term. Given current rate trends, investors who experienced last year's lows will find that even the lowest one-year rate feels expensive. How can most people address the cash-flow pressures that high interest rates bring? What repayment strategy should they choose for the next five years? Where will rates head over the coming years, and should borrowers fix for a longer or shorter term?
Economists have often tried to predict interest-rate movements, but their forecasts have frequently been inaccurate. This is largely because the past two years have brought so many events with major effects on New Zealand's economy, from the pandemic to war and other developments. These have created serious uncertainty about future mortgage rates. What will New Zealand's economy look like a year from now? Will the war in Ukraine have ended, or will it have escalated into a wider conflict? Will global and domestic inflation be brought under control, or will it continue to worsen? All these questions will directly affect the Government's stance on the OCR.
Mortgage Lab founder Rupert Gough recently offered investors some advice in an article, saying:
If you believe New Zealand's overall economic situation will be the same or better in a year's time, fixing for a shorter term of 1–2 years may be more suitable. Borrowers would spend relatively less on interest and, where possible, could use the savings to repay more mortgage principal. More importantly, if you believe the economy will be in a healthier position, rates this time next year will be below 6%, or even below 5% p.a.
Investors with a very pessimistic outlook may prefer to lock in a long-term rate. They may believe short-term mortgage rates will exceed 8% p.a. at some point, making a 4- to 5-year fixed term at below 7% p.a. a very reasonable choice now. Rupert Gough believes that while not everyone will fix for the longest possible term, this may be the most reliable option over the long run. Many homeowners, particularly investors, prefer long-term fixed rates because they know exactly what interest rate they will pay over the coming years and that their investment return will also be fixed.
People often say that choosing the lower rate for a shorter term is always the best option at any given time, but last year was an exception. Those who locked in longer-term rates before last year's sharp increases are now benefiting. That long-term strategy worked because the OCR and mortgage rates were at historic lows and entering an upward cycle.
Rupert Gough believes every borrower's circumstances differ, so choosing a suitable fixed term must depend on individual circumstances. For now, taking a short-term rate is relatively affordable, meaning fixing at around 5.35% p.a. He recommends making repayments as though the rate were 6.79%. If borrowers cannot do this immediately, particularly those coming off a low rate of 2% p.a., they should aim to reach that level within 3–6 months. Making repayments calculated at a higher rate while fixed at a lower rate means the extra money repays more of the mortgage, potentially saving borrowers substantial interest by the end of the fixed term. Likewise, once borrowers are accustomed to regularly making higher repayments, the shock of refixing at a higher rate will be considerably smaller.
To discuss how to choose a fixed mortgage term, YIJU New Zealand also urgently contacted two experienced mortgage advisers at Huarong Finance. Through these conversations, we hoped to learn the latest developments in the lending market.
Q: Among the clients you are currently helping, are more choosing short or long fixed terms? How can borrowers determine the best fixed term for their circumstances?
Charles Wu: Currently, my clients are split roughly equally between those fixing for 1 year and those fixing for longer. I generally tailor my advice to each client's circumstances. For example, if a client has a relatively high overall loan-to-value ratio, expects stable income over the coming years and has a conservative outlook, a medium- to long-term fixed rate may be more suitable in the current environment to manage the risk of substantial future increases. If a client expects income fluctuations over the next year and wants to preserve more cash flow, they may seek the lowest possible repayments over that year, then repay some principal when the one-year term ends to reduce the following year's interest. Clients planning to sell or refinance soon may be better suited to a short fixed term to reduce break costs when repaying the loan. Overall, choosing a suitable fixed mortgage rate requires consideration of financial resilience over the coming years, major life changes such as plans to have a baby, and the client's psychological ability to cope with potentially rapid interest-rate increases.
Toby Shi: With interest rates rising rapidly recently, most clients I am seeing want to fix for two years or longer. The main reason is uncertainty about how far rates will rise. Although they cannot know which fixed term will minimise interest costs, fixing for longer gives them certainty about mortgage outgoings over the coming years and helps with household budgeting. At the same time, we need to understand that banks also set their short- and long-term rates based on forecasts of domestic and international economic conditions.