Cloud over borrowing
It may be too late to rethink your mortgage before the Official Cash Rate Review.
Sunday, November 7th 1999, 12:00AM
by Paul McBeth
The dream run for floating mortgage rates has come to an end. Low and steady since late last year, they're on the rise.
The Reserve Bank is expected to sanction the upturn in market rates next Wednesday (November 17) by lifting its official cash rate from 4.5 per cent to 5 per cent, and even signal further rises through its Monetary Policy Statement.
The prospect of increased borrowing costs reopens for homeowners - current and prospective - the debate about fixed versus floating mortgages.
A flurry of increases in floating mortgage rates, kicked off a fortnight ago by Bank of New Zealand, has reminded homeowners not to take this rates for granted.
Floating rates had stuck at 6.5 per cent (for the trading banks) since late last year but now range 0.25 percentage points higher. However, the likely OCR rise and accompanying Reserve Bank outlook could well bump them up still further.
ASB Bank economist Rozanna Wozniak says the general consensus is that the OCR is going up at the next review.
"Where people are divided is whether it's by 0.25 or 0.5 percentage points. I actually think that in the overall scheme of things it's neither here nor there," she says.
"What happens to the ninety-day bank bill rate (and hence floating mortgage rates) really depends on the outlook for the next few months and what the Reserve Bank says in the text of its Monetary Policy Statement."
Wozniak expects floating mortgage rates to peak around nine per cent in late 2001/early 2002 but says the rises will be piecemeal, thanks to the stabilising effect of the OCR.
So, what should people do with their mortgage?
"It depends what sort of uncertainty they're willing to live with," she says. "Personally, I'd probably be opting for one of those short-term fixed rates, say one year. If you think you're likely to want to make lump sum repayments, put some on floating."
Across town, Bancorp economist Stuart Marshall says it's too late to act ahead of the OCR review, as markets have priced in the expected rise. He says floating and short-term fixed rates will keep rising next year because of the Bank's view on monetary policy.
"However, long-term mortgage rates are more influenced by inflation. If there's a Labour/Alliance Government, then those long-term rates are likely to go up too."
Marshall himself has quarter of his loan on a floating rate and the rest fixed.
"The best advice, and certainly what a lot of New Zealanders have done, is go away from an all or nothing approach. If you're taking out a brand new loan, I'd fix at least half.
"However, the first question is: how much can you afford? If the current fixed rate is absolutely the top, then don't take a risk. Fix."
Bank of New Zealand's chief economist Tony Alexander is another mix-and-match man: at the moment, he's keen on a combination of two-year fixed (at around 7.80 per cent) and floating. He says that fixed portion offers some insurance against changes in floating rates at a reasonable cost, and it will also mature after he thinks both floating and fixed rates will peak.
Like Rozanna Wozniak, he's expecting floating rates to stop their rise around nine per cent, but he thinks that will happen in early 2001.
However, guessing rate moves is only part of the equation for homeowners. If you're likely to move house soon or have spare cash to pay back your mortgage, you won't want to lock into a fixed term loan no matter how attractive.
Martin Shepherd, sales manager for property funding specialists Loan Plan, puts it bluntly. "Fixed rates can be dangerous and, for a lot of people, they end up costing them money."
In general, he suggests taking out a fixed rate of no longer than one or two years and leaving some floating to reduce interest costs and allow lump sum repayments.
"But I still believe that what people should do should be worked out on a case-by-case basis," Shepherd says.
He also says a redraw facility can be the way to go. These are usually available as an option on standard floating mortgages and mean that, if you pay in a lump sum or boost your repayments, you can get that extra money back later without any hassle. However, you can't redraw your regular repayments.
That differs from a revolving credit facility, where you establish an approved level of borrowing and can usually borrow right back to that original amount. The advantage is that you can run an all-in-one account and have spare cash reducing your mortgage interest bill, rather than earning peanuts in a savings account.
However, Shepherd says these products suit people such as real estate agents or contract workers who are paid irregularly and "who may need the comfort of a giant overdraft", and perhaps also small business owners or self-employed people who have variable cash-flow.
"For your typical mum, dad and two kids in their own home, it's totally unnecessary," he says. "A redraw facility also takes the discipline out of managing a line of credit product."
Financial consultant and author Martin Hawes, in Five ways to save more money on your mortgage, says that it now suits most people to have two or more different mortgage facilities. How you determine the split is critical: he says the key is to have as much of your loan as possible on the cheapest rate (and that's probably fixed), with just enough on a floating rate so you can repay debt with any extra income.
If that's all too difficult, you can take the approach suggested by Apex Mortgages general manager Kieran Trass. He calls it mortgage cost averaging and it involves splitting up your debt into lots of smaller loans each maturing at different times.
Trass says that averages out any interest rate moves and reduces the stress of deciding whether to fix or float. The downside is that you can miss out on any special rates offered by lenders and you'll have to pay fees each time a fixed loan expires.
He says the usual advice to "fix some and float some" gives people flexibility and some certainty. However, they may not realise that, when they're close to the expiry date of the fixed portion, they're back to exposing their whole loan to interest rate moves.
Counting the costs of changing
If you're thinking of changing your loan, you're in good company. Figures cited by mortgage lenders show that Kiwis change some detail of their mortgages every 18 months on average, and change loans completely every five years.
Some points to consider:
- Think about your own circumstances before you go chasing rates. If you're likely to move soon, then fixed rates won't suit as you'll pay a hefty penalty to break them. They usually don't allow extra repayments either: is it likely you'll earn more, inherit money or win on the greyhounds before the loan matures?
- Shop around. Either use a reputable mortgage broker or get organised yourself to find the best deal. Don't forget the direct banks and non-bank lenders. Visit your current mortgage lender to see what they can offer. Have things changed since you first took out the mortgage? Can you consolidate more expensive debt such as credit card debt or personal loans?
- Count the costs of switching. You may be saving on rate, but that's offset by the other charges you could be up for. These can include establishment fees for the new loan(sometimes a flat fee, sometimes a percentage of the amount you borrow) and any charges for setting up new accounts, valuation fees(say $300 to $500) legal costs for discharging your existing mortgage and putting a new one in place (around $600) and penalties for breaking any existing fixed term loans.
Most lenders now calculate the penalties for fixed rate loans based on how early you're repaying the loan and where interest rates are currently. If rates are moving rapidly, you can be caught out: Banking Ombudsman Liz Brown tells of one case where a bank customer was told the penalty would be about $300 but it eventually ran into the thousands three or four weeks later.
Too much hassle? If you've got any of your mortgage on a floating rate and have even a few dollars spare for repayments, you can trim a surprising amount off your total interest bill. Ask your mortgage lender to calculate the effect of changing your repayments or use one of the online mortgage calculators (on bank and other lenders' websites).
This article first appeared in the New Zealand Herald on Saturday November 6.