Adrian Orr and the Reserve Bank of New Zealand (RBNZ) has surprised markets by cutting the Official Cash Rate (OCR) by 0.50%, double what most experts predicted. This could signal lower mortgage rates ahead, but does that mean now is the best time to fix your mortgage rate? In this article, we’ll explore the factors driving this change and help you decide whether to lock in or wait.
Why Interest Rates Are Dropping
Several key factors are contributing to the recent drop in interest rates:
- Inflation Control:
We’re getting close to the RBNZ’s inflation target. In June, annualized inflation dropped to 3.30%, and it’s expected to fall below 3% by September. However, inflation is made up of two parts: tradeable (goods imported into New Zealand) and non-tradeable (local goods and services). While tradeable inflation has fallen from 8.70% to 0.30%, non-tradeable inflation is still stubborn at 5.40% but is expected to decrease slowly. - Recession Impact:
The economy, when adjusted for inflation, has essentially regressed to pre-COVID levels. This means the high interest rates we’ve been enduring are unsustainable for the current state of the economy. - Global Trends:
Other major economies, like the US, Australia, and Europe, have begun to ease their monetary policies. If they hadn’t softened their stance, the RBNZ likely would have delayed cutting the OCR further. If they cut earlier, it could make it more expensive to buy goods offshore, therefore, taking longer to bring inflation down.
However, a Warning:
Though rates are falling, the RBNZ’s main focus is on inflation. Unexpected events, such as geopolitical conflicts, could push up oil and shipping costs, making tradeable inflation rise again. This could slow down the pace of future OCR cuts.
Should You Lock It In or Wait?
Now that the RBNZ has cut the OCR, you might be wondering: Is it the right time to fix my mortgage rate, or should I wait for rates to drop further? Here are some key strategies to consider:
1. Lock In Early for Certainty
Most banks allow you to lock in a rate up to 60 days before your mortgage renewal date. If you value the certainty of locking in a rate now, this could be a smart option. However, with rates trending downward, many borrowers are choosing to wait until the last one or two weeks before their renewal date to see if they can secure an even lower rate.
2. Floating Strategically
While variable interest rates are currently about 2.00% more expensive than fixed rates, there may be an opportunity to wait and benefit from a lower rate in the near future.
For example, let’s say you think rates for a 12-month term could fall from 6.09% to 5.59%. If you stay on a variable rate, you might wait up to three months for the fixed rate to drop. This strategy can work if you expect a significant rate reduction, but waiting too long could also backfire if rates don’t fall as quickly as expected.
Mortgage Strategies to Consider
1.Lean short, but maybe not too short.
The trend has shifted, and long-term rates don’t appear to offer a compelling enough of a rate discount for the added stability. Now, because the RBNZ’s cutting cycle isn’t guaranteed longer term rates still have their place if you want the stability but consider the following before making your decision.
- The Trade Off – You have to compare them and see if it’s worth it for you. Whether that discount is worth it, that’s the question.
- For example, fixing for 3YR at 5.65% is like fixing for 2YR at 5.69% and then for 1YR thereafter at 5.57%. Do we think rates may be lower than 5.57% in 2YR’s time? If so, then the 3YR rate is not very compelling. That’s because the gap between 3YR and 2YR is just so small.
- When we do the analysis for a 1YR rate vs. a 6M rate, you can think of 1YR at 6.09% = 6M at 6.69% + 6M thereafter at 5.49%. Is the rate likely to fall to 5.49% over the next few months? Maybe, maybe not! But it’s definitely not guaranteed and it’s not that compelling the 6M rate could fall by 1.20% in such a short time frame (albeit the 12m rate is almost there). That’s because it’s the opposite of the other example where the gap between the 6M & 1YR is so large.
2. Consider a split mortgage.
Finding the perfect rate at anytime is an impossible feat, but after narrowing down your choices splitting your loan into different ‘tranches’ can help spread that risk of being caught on the wrong rate.
For example, after narrowing down to say a short term rate strategy, you could split your loan between say 6 / 12 / 18 / 24m fixed rates. There is no magic number of tranches, but we find that most borrowers would settle on 2-3 tranches.
This strategy however, is not for everyone.
3. Watch out for break fees.
Break fees are a genuine concern at the moment as the market has shifted lower quickly over a short period of time so in most cases as of now, breaking loans is not cost effective at all even after factoring in the lower mortgage rate today.
If you’re planning to sell a property, refinance to a new lender or some other major change lining up your loan renewals will reduce your risk of possible break fees now that rates are falling.
Break fees generally fall over time, however, if market conditions move lower break fees could become worse so factor this in for any major refinance or sale event.
How much are your break fees? We can find out for you, or you can contact your bank for a quote.
4. Keep payments high, even as rates fall.
This is a simple but powerful strategy. As rates go down, your required mortgage repayments will drop too. But instead of reducing your payments, consider keeping them at their current level. Doing this allows you to pay off your loan faster and reduce the total interest paid over the life of the loan.
- For Example: If your mortgage payments drop by $100 per month with the lower rate, continuing to pay that extra $100 means it goes straight towards your principal balance. Over time, this can shave years off your mortgage and save you thousands in interest.
5. Lump sum payments.
Whether interest rates are rising or falling, making lump sum payments are often a good idea!
- Alternative to Investment? Every extra dollar towards your loan effectively gives you a guaranteed net return equal to your mortgage rate. If you like the idea of prioritizing paying down your loan, this will help achieve it. However, it’s not the only way. You could possibly re-invest those funds elsewhere. The trade-off is the rate of return. The savings on a loan are guaranteed, but the returns in a managed fund are not.
- Forget the Term Deposit. If you’re finding yourself part way through your fixed term, rather than setting up a Term Deposit you could instead make a lump sum payment. Paying down the loan with the highest rate isn’t always the obvious choice – break fees can be a factor, so we can run an analysis to see where the best bang for buck would end up at.
- Access to funds. Don’t ignore this, we need to be careful is depending on which lender you’re with, once the loan is paid down, it’s paid down. Some lenders offer a ‘redraw’ facility so you can re-access these funds without too much difficulty, however most lenders don’t – so using an offset loan or revolving credit facility may be a great way to still have access to your funds and benefit from savings at the same time.
Crystal Ball?
RBNZ: The RBNZ has earlier offered a guideline of an OCR of circa. 4.00 – 4.25% in a years’ time and circa. 3.00 -3.25% in two years’ time. However, as of today, looks like this might be achieved faster than earlier expected.
Market: Broadly agrees, with perhaps a more optimistic edge. The closest clue are ‘swap rates’ where the 1YR rate today reflects at 4.11%, which means an OCR of possibly as low as 3.50-3.75% in a years’ time. The two-year swap rate is today circa. 3.50% which forecasts a low of 3.25% in the cutting cycle.
Mortgage Rates: We can’t only look as the swap rates, as mortgage rates are also based on term deposits and other costs of funds. However, it’s almost certain to see rates in the 5’s% as a mainstay of 2025 and possibly high mid to high 4’s by the time this is all over.
Final Thoughts
It’s exciting to see the trend beginning to turn around, aligned with spring, it feels like the general mood in the industry is lifting. However, this is a cautionary tale, we can get swept up in the sentiment and forget why interest rates are now falling and how to make decisions around this.
If you’re still unsure whether now is the right time to lock in your rate, or if you have any questions about how these changes affect your situation, don’t hesitate to reach out to us, we’d be happy to help.
