The bank suggests people should only go for a floating rate if they intend to pay off their mortgage quickly.
Although the Reserve Bank left interest rates unchanged in October, retail mortgage rates are higher across the curve compared to a month ago, from the one year fixed rate and above. As fears of a recession in the US fades and prospects for cuts to US interest rates get pushed out, expect higher New Zealand mortgage rates at the long end of the curve, namely 4 and 5 year fixed rates.
The current mortgage curve is not looking particularly attractive at present. Even the lowest rate on offer, which is at the 5-year end, is getting close to 8%.
While locking in for that duration provides a degree of certainty in terms of repayments, this strategy does not provide any flexibility to take advantage of lower interest rates when and if that eventually occurs. Ultimately, the decision depends on individual circumstances and whether one has strong views on the interest rate outlook, but fixing for shorter durations initially comes at a cost of up to 60 basis points, which may be worth paying for the added flexibility to take advantage of lower rates if they fall.
With the Reserve Bank expected to keep official interest rates on hold for longer, but with a tightening bias, we do not expect 1 and 2 year fixed lending rates to head materially lower anytime soon. Our view is that 1 and 2 year fixed lending rates will head below 7% in early 2008, but the risk profile is tilted towards a more elongated period of higher rates.
Take a balanced (diversified) approach. Spread your risk by having exposure to different parts of the yield curve.
Longer-dated (5-year) rates still offer some value given their historical average, the risk profile for rates and the prospect for an elongated period of higher interest rates. A key question to ask yourself as a property investor is how strong you expect the market to remain. If the answer is strong, lock in for 5 years because the Reserve Bank will not be lowering rates, and may still increase them. Those with a slightly shorter-term horizon should consider the 3-year rate.
Take a 12-24 month rate now, in anticipation of more favourable 2-year rates in 2008. A succession of shorter-term rates could leave you better off over five years than taking a five year rate by the time the loan comes up for renewal. This approach is consistent with our core economic view that rates are set to fall aggressively from late-2007. Those bearish the property market should be hedging here.
If cash-flow is an active constraint, look at extending the term of the loan. While this means paying more in interest costs, at least it provides some cash-flow relief in the near-term.
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