Whether to float, fix and for how long is a common question for borrowers to ask.
With interest rates much higher and household budgets considerably tighter, there’s more riding on these decisions today.
As with most money matters, the answer depends on your situation. However, let me give you my take on this.
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I think there’s a good chance our Official Cash Rate (OCR) could be at its peak for this cycle.
Governor Adrian Orr and his colleagues will be encouraged by Tuesday’s inflation figures, which were the lowest in two years.
Stubborn domestic pricing pressures will keep it on alert, but the Reserve Bank is in a holding pattern for now.
It’s hard to see any OCR change coming at the November meeting, which is the last one for the year.
Beyond that, the next monetary policy decision comes in February. Hopefully, in four months’ time inflation will have slipped a little further, and the labour market eased slightly too.
The new government will have also taken shape, and we’ll have a clearer picture of how policy changes might impact the outlook.
Some economists have noted that National Party tax relief proposals could put upward pressure on inflation, thereby pushing interest rates even higher.
That’s possible, but if NZ First is in the mix I’m not so sure they’ll be supportive of tax cuts.
Another reason I see the Reserve Bank sitting on its hands is that it’s still getting very good bang for buck out of its previous OCR increases.
Most of us opt for fixed rates, which means we don’t feel the effect of higher rates under our loans come up for renewal.
That’s why they say monetary policy operates with a lag, because it takes time for changes in interest rates to work their way through the economy.
The faster the move in interest rates, the bigger impact when reality catches up.
Right now, fixed mortgage rates are around seven per cent, give or take.
However, the average fixed rate borrowers are paying is only 5.2 per cent, because many of us are still enjoying rates that we signed up for some time back.
As those roll off, we’ll move onto the higher current rates and keep getting hit in the pocket even though the Reserve Bank has been on the sidelines since May.
What’s a borrower to do if their mortgage is coming up for renewal?
Floating rates are the highest at around 8.5 per cent, but unless you want maximum flexibility there’s little incentive to pay this premium.
Looking across the fixed rate options, the shorter timeframes are most expensive with six or 12 month terms at just above seven per cent.
As you go out to three or five years, fixed rates come down into the mid-sixes. That’s where you’d head to keep your monthly bill as low as possible, but there’s a risk with this approach.
If inflation continues to cool, the economy slows (as people roll onto current rates) and the OCR turns out to be at (or close to) its peak, the tipping point could be upon us next year.
Those who opt for a lengthier term will save some money in the immediate future, but they might find themselves stuck on higher rates against a backdrop of declining interest rates.
If you believe that’s how things could play out, it might be preferable to select a shorter-term rate and keep your options open.
You’ll pay slightly more right now, but you’ll be able to take advantage of lower rates if that’s where things are at when it’s time to renew your loan the next time around.
Sometimes the need for certainty around your household budget trumps all of this, so if long-term repayment clarity will help you sleep at night, maybe there’s your answer.
If in doubt, get some advice.
Just remember things can change quickly in financial markets, so what you’re hearing today from banks, policymakers and economists won’t necessarily be as relevant by Labour Day of 2024.
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Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.
Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.