Market Updates

Interest Rate Update – when should I fix? (updated 01/11/11)

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.5 percent.

I remain sceptical that banks may move before the OCR in anticipation of catching many clients unaware. As of the date of this article wholesale interest rates were already beginning to increase in anticipation of more interest rate fix requests. This will be a game of musical chairs - the last ones to fix will lose out.

I also feel (based on commentary) that the rates will become a flat (yield) curve over the next 18- 24 months (that means the 6mo fixed through to 5 year fixed will be at similar levels).

So according to bank economists the interest rates are predicted to increase to around 8%. The banks will likely continue to make the floating interest rate attractive until the transition is complete, and once this has occurred they will then raise the floating rate - providing no place for floating rate mortgages to go but up by 2% fairly suddenly.

Interest rates are less simplistic, so I will start by referring you to our website http://www.newbuild.co.nz/Home-Loans-And-Insurances/. This graph shows that it's more about when to fix and for how long (term), than at what rate to fix.

Timing is critical

While we have rules for everything we all know that life sometimes throws curveballs. But there are some simple rules when it comes to interest rates that generally hold true:

1. Fix short at the top of the interest rate cycle and long at the bottom. We are not at the bottom any more, but the only way interest rates look to be moving is UP
2. Watch out for Advertised discounted interest rates - these are designed to favour the bank. I expect the banks will advertise short term fixed rate loans between 1 year and 2 years. It's not the rate going in you need to be aware of but what the rates are likely to be coming out
3. Watch out for the bear trap. The bear trap is an interest rate that seems too good to be true - it usually is.
4. Be aware of banks offering lower interest rates. We are often driven to the lowest interest rate only to discover later the loan had ill-disclosed fees, or worse, an onerous break fee structure. Not all the banks use the same formula, and there can be a big difference between banks. So that's the easy part sorted. The hard part is knowing when. I think firstly that banks will move before you think they should – it's pre-emptive. Banks are pushing people to float because it is so attractive. That's a trap. So how long do you risk the low floating rate? Really hard. But a post election decision makes some sense.
5. The best rule: it's not about the interest rate as much as the timing. In other words there's no sense getting the lowest interest at the top of the economic cycle if it's fixed for five years, or the lowest interest rate at the bottom of the cycle if it's a 1 year fixed. You may need to read this again to understand it.

I wonder aloud if the Christchurch rebuild is sucking so much energy out of the economy and recovery has been a bit more delayed than most anticipated, but recent figures indicate the Reserve Bank will now need to move to suppress inflationary pressure. So how can you protect yourself from higher interest rates on your mortgage?

Conservative approach – fix for as long as you can afford Aggressive approach – stay on floating and fix for as long as you can once you see real strong talk of rates going up (and hope it's not too late). Cake and eat it too approach– split your facilities further and spread your risk.

Remember not to be greedy – all the fixed rates are actually historically very good today.

*Disclaimer: The information provided is subject to change and is a summary of forecasts and predictions from professionals. You should seek specific advice about when you should fix your loan and for how long. Commentary by Ian Webb.

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