There’s more to mortgage rates than the OCR

There’s a lot of excitement out there amongst borrowers, particularly those with a mortgage renewal coming up.

The message boards are full of people speculating on how low rates will go, and strategising how to play it for maximum advantage.

While the optimism is justified, some caution applies as well.

If you’re in the midst of that refixing decision, there are two things to be aware of.

The first is that it’s not solely about the Official Cash Rate (OCR).

The OCR is important, but global economic conditions, wholesale interest rates and competition among lenders can also influence mortgage rates.

Banks exist to make a profit, so their overall funding costs are a crucial driver of mortgage rates.

Before lending you money for a home, they need to borrow it first and they do that from a range of sources.

Those with term deposits and savings accounts have lent the bank money.

It pays them interest in return, and offers those funds out again to other people at a higher rate.

Banks also borrow from the Reserve Bank and from international markets.

All these things influence funding costs, which in turn impact how much they charge for mortgages.

Bank funding costs have been low these last few years.

The pandemic saw the Reserve Bank introduce a range of additional monetary policy tools, such as the Large Scale Asset Purchase programme and the Funding for Lending initiative.

These are behind us now, but they allowed banks to borrow at a very low cost during that period.

When the OCR started rising in 2021, these tools limited the impact of those increases on mortgage rates.

The two-year mortgage rate fell to a low of 2.55 per cent in 2021, then rose by 450 basis points to a peak of 7.05 per cent in 2023.

That’s 120 basis points less than the than the increase in the two-year wholesale interest rate from its lowest to highest point, and 75 basis points less than the corresponding rise in the OCR.

As borrowers were shielded from the full force of rising rates back then, we may not see the same “one for one” decline as they fall.

Term deposits are another important funding source for banks, and these didn’t increase as much as the OCR either.

According to the Reserve Bank, the average cost of all deposit accounts increased by 380 basis points from late 2021 until the middle of this year.

This suggests that only about 70 per cent of the OCR increase was passed through to deposits.

Term deposit rates have further to fall but they might not decline quite as much as the OCR, again leaving funding costs from this source slightly higher too.

International factors (such as a new US President) can also have an impact, as these influence longer-term interest rates.

Despite OCR cuts in August and October, our longer-term wholesale rates have been rising over the past two months.

My second word of warning is to remember that financial markets and the banks already have a fair idea of what’s ahead.

They adjust their rates and prices in advance based on those expectations, rather than waiting.

The Reserve Bank is likely to cut the OCR by another 0.50 per cent next Wednesday, but that doesn’t mean we’ll see an across the board fall in mortgage rates the day after.

Floating and short-term rates might react, but there’s every chance this is largely “in the price” when it comes to anything lengthier.

In fact, for some mortgage terms most of the move this cycle might’ve already happened.

Financial markets see the OCR settling at 3.5 per cent this time next year, in line with the average forecast from the big four banks.

The two-year wholesale interest rate is typically a little higher than the OCR, and the two-year mortgage rate has historically been about two per cent above that.

Right now, my bank is offering a two-year rate of 5.65 per cent, which is almost bang on that rule of thumb.

I wouldn’t say this is “as good as it gets” for borrowers just yet, but we might be a little closer to that point than many think.

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