Interest rates below 5%? New Zealand's housing market enters an era of twin declines: how will mortgage and construction costs shape its future?

New Zealand mortgage borrowers could see mortgage rates below 5% in the coming months, a prospect generating considerable market anticipation. Several economists predict that continued falls in wholesale rates and potential Official Cash Rate (OCR) cuts will be the main drivers of this trend. However, industry views differ on whether rates will actually fall below 5%.

 

What is driving lower interest rates?

 

Continued falls in wholesale market rates provide strong support for lower mortgage rates. Data shows that the two-year swap rate has fallen from its peak of 5.79% in October 2023 to around 3.4% now, while the one-year swap rate has dropped from 5.69% in February last year to about 3.5%. Squirrel Chief Executive David Cunningham said mortgage rates could fall by 0.5% within the next month even if the OCR remains unchanged. He said banks currently pay 5% on six-month term deposits, while the wholesale rate for the same term is just 3.8%. As term deposit rates fall to 4.5%, banks will have more room to lower mortgage rates.

The OCR is also expected to be cut by 50 basis points in February this year, with a further 50-basis-point reduction anticipated before year-end, bringing it to 3.25%. This policy direction further strengthens market expectations of lower mortgage rates.

Diverging market views

While some experts are optimistic about rate cuts, others suggest the scope for reductions may be very limited. Westpac Chief Economist Kelly Eckhold considers a two-year fixed rate below 5% unlikely, expecting it to stabilise at around 5.5%.

BNZ Chief Economist Mike Jones said that although OCR cuts would create further room for lower rates, market expectations are already partly reflected in existing wholesale rates. Economist Shamubeel Eaqub also said mortgage rates generally track wholesale rates. Although recent reductions have been small, there is still room for future adjustments.

 

The impact on borrowers

 

The latest data shows the lowest three-year fixed mortgage rate among New Zealand's five major banks is 5.49%, offered by ASB and Westpac. However, even a reduction of just 20 basis points could provide substantial financial relief for borrowers approaching a rate reset. For example, a borrower buying a median-priced property with a 20% deposit would spend around NZ$9000 less in annual interest than at the start of 2023.

Notably, around 51% of mortgages are due to be repriced in the first half of this year, meaning more borrowers will be able to benefit from potential rate reductions. As rates stabilise, more borrowers are also expected to choose medium-term fixed rates of 1 to 2 years, easing concerns about the uncertainty of short-term floating rates.

Construction cost changes alongside falling interest rates

 

Alongside the prospect of lower mortgage rates, changes in New Zealand's construction costs are adding a new dynamic to the housing market. According to CoreLogic's latest Cordell Construction Cost Index (CCCI), the cost of building a standard three-bedroom, two-bathroom standalone home rose just 1.1% in 2024. This was down further from 2.4% in 2023, and well below the sharp 10.4% increase in 2022.

CoreLogic Chief Economist Kelvin Davidson said this trend was unsurprising. Over the past 12–18 months, pandemic-related pressures on building material supply chains have eased substantially. Slower residential building consent issuance and actual construction activity have also reduced demand on industry capacity, restraining growth in material and labour costs. Although the construction downturn has been prolonged, the high starting point means current residential construction levels remain above those of previous economic troughs, such as the period following the global financial crisis.

 

Building material prices moved in different directions in the fourth quarter of 2024. Carpet costs, for example, rose 3%, wall insulation increased 3%, and plasterboard prices climbed 4%. By contrast, prices for exterior timber products fell 5%, while kitchen cabinetry costs declined 3%.

Outlook: balancing cost control and demand for new builds

 

Kelvin Davidson said falling mortgage rates should support a gradual recovery in construction activity in 2025, while overall cost growth is expected to remain relatively manageable. Stats NZ data also suggests new home construction may already have bottomed out and begun to recover, with some growth expected in 2025.

Notably, the combined effect of loan-to-value ratio (LVR) rules and debt-to-income (DTI) restrictions is gradually encouraging buyers to favour new homes. Although DTI restrictions currently have little impact, their effects could emerge in 2025 as mortgage rates fall, gradually shifting demand from existing homes towards new builds.