Fixed or floating?
The mortgage markets are thriving at the moment with the bank’s vigorous lending fuelling an ever rising property market. This is a far cry from 2008 when we were gripped by the global financial crisis and property was the biggest white elephant in the room. I thought I would look into this.
The RBNZ site is a great place to obtain economic data. For this article I have obtained the OCR (On-all Cash Rate), floating mortgage rates and two-year mortgage rates since 1998 (see figure 1). In this article I will explore their relationship.
Floating mortgage rates set by a bank should be a margin, based upon risk, above the bank cost of funds, also called the “interbank interest rate”. Interbank interest rates are largely a function of the OCR set by the Reserve Bank.
The RBNZ’s primary purpose is to maintain a stable currency through controlling the rate of inflation. It has been able to achieve its primary objective of maintaining annual inflation rates between 1 and 3% since this was mandated in 1999. (Given New Zealand’s small economy and reliance on overseas markets, a stable dollar is particularly important to us.)
The RBNZ will increase the OCR in a heated market to restrict the economy. Conversely it will reduce the OCR in a stalling market to promote spending.
The graph below shows the gradual increasing of the OCR up to the end of 2008. This delineates the property boom the market was experiencing, and the RBNZ’s attempts to restrict it to this date.
As the graph shows, the global financial crisis of 2009 and the resulting property slump triggered the RBNZ to reduce the OCR to record low levels in an effort to stimulate the economy through the GFC.
While bank mortgage rates have always loosely followed the OCR as expected it should be noted that up until 2009 the average margin above OCR was 2.1%. After the GFC mortgage rates tended to be 3.5% above the OCR. The additional 1.4% margin charged by the banks reflects the extra perceived risk in the markets after the impact of the GFC.
The recent record profits achieved by the banks in New Zealand can no doubt been partly attributed to this additional risk margin the banks are charging. Monetised, with the value of New Zealand mortgages sitting at around $177 billion, this additional margin reflects marginal profit of around 2.5 billion annually for local banks.
If the banks were still pricing in a pre-GFC margin, all of our mortgages would all be well below 5%.
Despite this additional risk margin, due to the low OCR, our mortgage rates are still at record lows.
At the date of writing the floating mortgage rates are roughly 5.75%, the average floating mortgage rate prior to the GFC was 8.4%. This 4.7 billion dollar saving represents around 3% of our GDP and must be considered one of the main drivers of our current property boom.
The banks are now taking advantage of this boom lending to 90% or more on residential properties. Despite the additional margin they are earning, they are still able to gear borrowers to the hilt with mortgages priced at the post GFC rate.
The Reserve Bank is now signalling, however, that it wants to cool this expanding property market and most punters are picking OCR rises at toward the end of this year.
What then happens to the poor New Zealand borrower lulled into a false sense of security with our low post-GFC borrowing rates?
Hopefully the borrowing public will be aware of the unusual hiatus they are experiencing and fix their mortgages low enough and long enough to be able to reduce them to levels that they can service should we return to pre-GFC lending rates.
This article is not intended to give financial advice. Any person intending to borrow or reviewing the terms of their borrowing should seek and evaluate information from a wide variety of sources and/or seek independent financial advice from a registered financial adviser.
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