Over the past week several economists have commented that "now is a good time to fix mortgage rates". I found this recommendation puzzling and was a little sceptical in that the banks have a vested interest.
(Pardon the pun).
What economists such as Westpac's Dominick Stephens are saying is that over the past year the swap rates for borrowing by the banks have reduced. A swap rate being an international benchmark interest rate for the term mentioned. Mortgages are funded from short-term rates such as 90-day bills and three-year swap rates.
Mortgages are priced at about 2% above the 90-day bill rate for floating rates, or, a set-period swap rate for fixed rates. For example, over the past six months the three-year swap rate has fallen from 3.71% to 3.28%.
Ninety-day bills have reduced also from 3% to 2.7%. This suggests three-year fixed rates should be about 5.3%. In fact according to interest.co.nz the common three-year fixed rate from the major banks is 6.1%.
So the recommendation to fix rates is not because fixed rates have reduced (because they have not) but because the swap rates have reduced. Therefore fixed mortgage rates for two to four years are at the lowest they will be in the current environment. It still seems a bit like a vested interest because the Reserve bank is not under pressure to raise the Official Cash Rate (OCR). The Reserve Bank Governor (Dr Bollard) has indicated that he does not expect to raise the OCR before the end of this year.
It is my opinion that borrowers should not rush into totally fixing their mortgage, as floating rates will remain low, if not static for some time yet.
Many borrowers comment that they like certainty in knowing that their repayments are constant on a fixed rate rather than changing with floating rate changes periodically. However, floating rates offer more flexibility.
It pays to check what the terms of your loan are.
In the period from June 2008 when the OCR was reduced from 8.5% down to 2.5% in April 2009, many persons discovered penalties in attempting to get off fixed rates. These penalties are there because the banks are always keeping an eye on their liabilities such that they require certainty as well in knowing their commitments.
There is no doubt that repaying debt is the best investment you can make. On present tax rates of 17.5% you have to earn $1.21 for every dollar you pay off your mortgage. On a higher 28% tax rate the amount before tax is $1.38. You cannot earn 21% (or 38%) on investments so pay as much as you can of your after-tax earnings. Most lenders do not allow additional payments on fixed-rate loans.
The answer is to hedge your bets by having part of your mortgage on fixed rates and part on floating. What proportion you choose depends on your personal circumstances in what you can afford. My recommendation would be to concentrate on paying as much as possible into your floating mortgage rate portion. You can set any amount over and above the minimum required to give certainty.
• Peter Smith is an authorised financial adviser and a certified financial planner and is the principal of Kepler Group Otago Ltd, Dunedin. Email: pete@keplergroup.co.nz . A disclosure statement is available on request and free of charge.