Putting billions back in mortgage borrowers pockets

Over the past three years higher interest rates have translated in dollar terms to a $10 billion increase in mortgage borrowing costs.

It is an increase that has severely stunted household spending and economic growth, despite significant immigration and substantial pay rises, David Cunningham, Squirrel Mortgages chief executive says.

“If anybody is wondering why New Zealand is now in such deep recession, there’s the answer. Precisely what the doctor, Reserve Bank Governor Adrian Orr, ordered.”

Cunningham says all that will start to unwind from next month.

“If anybody is wondering why New Zealand is now in such deep recession, there’s the answer. Precisely what the doctor, Reserve Bank Governor Adrian Orr, ordered.”

A whopping 80% of mortgages – as a proportion of the country’s $370 billion in home loan debt – are headed for an interest rate reset sometime this year. 

Of that, roughly 15% is on a floating rate, with the remainder made up of fixed-term loans due to mature within the next 12 months. 

Most economists are picking a 0.5% OCR cut on 19 February, with wholesale markets pricing a total of 1% cuts to the OCR, down to 3.25%, by September this year. That’s on top of the 1.25% of OCR cuts already made.

“Of those heading for a reset in the next 12 months, there will be some (those savvy borrowers who locked in four or five years ago at about 3%) for which the change will be a massive shock, substantially increasing their interest costs. Granted, after a long time being spared the pain most households have endured.”

For most, however, he says it’s good news. “Assuming that market pricing is accurate, and the OCR will be down at 3.25% by September, that will almost certainly see mortgage rates for terms out to two years drop to sub-5%.”  

That will put about $4 billion back in homeowners’ pockets.

Interest rate strategy

A quirk of the mortgage market in New Zealand is that banks take very fat margins on floating rate loans, Cunningham says. 

Floating rates are sitting at about 7.4%, on average, compared to more like 6% on six- or 12-month fixed terms. 

“The difference is mainly banks feeding the fat margins at the trough – incidentally, something the Commerce Commission’s market study into retail banking services should have addressed but didn’t.”

It’s why, generally speaking—unless it’s only for a small portion of a mortgage, or for a short period (say, less than two months) – mortgage holders are almost always better off fixing instead of floating. 

“Late last year, however, the market had one of those rare moments where floating became the recommended course of action for borrowers.”

With interest rates tracking downwards already, and further cuts on the horizon, mortgage advisers were advising their clients to take a floating rate for a few weeks, then fix after the November OCR review, enabling them to lock in at a better rate.

In the last few months of last year, up to 50% of new mortgages were settling on a floating rate—more than double the usual 20%. 

Where to from here? 

Once the RBNZ has the OCR back close to 3%, mortgage rates should settle near the top of the 4% to 5% band which is the range of the popular two-year fixed term for most of the five years before the pandemic, Cunningham says.

Westpac says lower mortgage rates have helped to revive interest among potential home and property investment buyers in recent months, with evidence of a lift in loan applications and increasing open home attendance.

The bank’s senior economist Satish Ranchhod expects this to translate to higher house prices this year.

“While this year may well be one where the improvement begins on the farm it could take a while to reach the café dwellers of Lambton Quay and Queen Street.”

It’s also important to remember conditions are better in the regions compared to urban centres because last year’s strong rise in the terms of trade is being felt there first, he says.

“We got a further reminder of this this week as dairy prices lifted again in the GDT auction as Chinese buyers returned to the auction.

“While this year may well be one where the improvement begins on the farm it could take a while to reach the café dwellers of Lambton Quay and Queen Street.”

Ranchhod says while borrowing costs are dropping, they look set to return to average levels, rather than the very low ones in the wake of the pandemic.

And while those reductions will help to support both economic activity and house prices, he expects the recovery to be gradual and will lead to a return to trend rates of growth, rather than elevated levels.