Mortgage Rates | Where to from here?

Collection of coins lying on a table

With wholesale interest rates tracking as low as they are, and ongoing ructions in Europe, there is plenty of keen discussion on interest rates. The opinions vary greatly and everyone has one. The pessimists out there are sure that Europe will implode and the Reserve Bank will be forced to cut rates further. It is certainly hard to see Europe sorting out its mess in an orderly way. It reminds me on the analogy that if you gradually heat up a frog in a pot of water, it won't jump out and will die.

Even here in NZ our economists and politicians won’t factor an implosion into their “working hypothesis” because they cannot forecast the unexpected. It only becomes "expected" after the event by which time it is too late! When (not if) Europe implodes I question if banks would necessarily pass on a further rate cut?  NZ has a lot of external debt so we are vulnerable to tightening credit markets and higher wholesale borrowing costs. I could only envisage the Reserve Bank reducing the official cash rate to offset otherwise increasing mortgage rates. Mortgage margins are already large enough to absorb higher wholesale rates. What we’d see is less discounting, no big cash incentives to switch banks, and tighter credit policy. It would be similar to what happened during 2009 and 2010.

The other view (not necessarily an alternate one) is that interest rates stay at historic lows for another year and then gradually increase. This scenario has inflation stable with a fairly high NZ dollar. It is a bleak low growth world where we spend the next 10 years laboriously working our way out of debt. The export-led recovery never arrives; we sell off the family china, don’t come close to balancing the budget, and lose a decade of opportunity because we just tinker with what we have. We all know we need to live within our means, which is a big shift from the debt binging of our past. It constantly staggers me how many people owe more on their house now than they did 10 years ago. Repaying debt will reduce expenditure elsewhere. You’d have to say the next 10 years are going to be unpleasant for retailers and the service sector generally as consumer expenditure ticks over with little or no growth. Bare in mind that the service sector and government are our biggest employers by a mile so it’s equally not a good employment story. With a lower tax take, we will see less government spending. Baby Boomers will also reduce their expenditure as they go into retirement and incomes fall. Gen X will keep pushing more money into debt repayment and superannuation, but especially debt repayment. The now much overhyped benefit from the Christchurch rebuild could provide some respite.

Then in Auckland we have a manmade problem with a lack of housing stock that could stoke up a bit of short-term inflationary pressure. Hopefully at some point this may help pick the construction sector up off the floor.  However, my overarching sense is that any confidence in the Auckland market is fairly shallow and could easily run out of steam later this year if global doom and gloom dominates the media. Given such a benign outlook my view is that we are in for a decade or more of historically low interest rates. Rates will still increase and decrease, responding to the ebbs and flows of the economy, but a high rate will likely have a 7 in front of it and the average rate through the next cycle will likely start with a 6. 10 years of more of the same. The concern will be with Government and that it always sees growth as our "get out of jail card" particularly when it comes to superannuation.

Mortgage Rates?

Given this overall context I wouldn’t sit around waiting for mortgage rates to fall further. The rates we can get today are as good as it gets. In my mind you should simply take the lowest rate on offer, whatever that is. At the moment the best rates are often the 1 or 2 rates around 5.00%. For a bit of peace-of-mind the 3-year rate at 5.35%-5.50% looks like great value-for-money. However 4 year and 5 year mortgage rates are still way too high. As always think about splitting your mortgage and having half on the lowest short term rate and half on 3 years.