Be wary of the five year fix

Be wary of the five year fix

Couple working out finances

The biggest threat to my view that all bar the one year fixed mortgage rates have now peaked has now fortunately backed off. The inflation data for the year to December were released this week and the annual rate of 7.2% is almost bang on market expectations for 7.1%.

When the previous number came out on October 18 it was 0.6% higher than expected and this led eventually to 1% extra going on fixed mortgage rates come the end of November, and the Reserve Bank warning about recession this year as being necessary to get inflation back down.

As yet we cannot say inflation is falling, though one or two of the many measures of underlying inflation have eased slightly. But the important thing is that we can say it has peaked, and with business and consumer confidence readings at appallingly low levels the weakness in the economy this year will see inflation fall away.

The release of the latest inflation number generated some small falls in wholesale borrowing costs which follow larger falls in recent weeks driven by falling inflation in the United States and some weak economic data.

Can we safely say that fixed rates have peaked?

Almost. One bank has just cut its three to five year fixed rates but lifted their one and two year rates. The one year rate rise was probably the toss of a coin. But the rise in the two year rate at a time when the cost to banks of borrowing money to lend fixed for two years has been going down suggests one of two things.

Either a simple desire to boost margins to even more above average levels, or a desire to try and encourage people to lock in with them as a customer for at least three years.

It is not often that the relationship between the one and five year fixed mortgage rates is inverse. That is, the one year rate is higher than the five year rate. The last time that happened was in 2008 and back then many people opted to fix for five years because they were saving about 0.5% compared with fixing one year.

But that was a mistake and at the time I wrote that I would not touch the five year rate with a bargepole.

I wrote the same in 1998 when the curve was also inverse and write the same now. Borrowers need to recognise that if they fix for five years now at about 6.5%, they are locking in a mortgage rate near the top of the 2.99% -7.0% range which it has traded in over the past eight years.

This is exactly the wrong point in the cycle to shift from fixing short to fixing long. But some people are going to do it. Why? For some it will be because they always take whichever rate is the lowest when their mortgage comes up for renewal. That would have worked great if their rate matured two years ago when the five year rate was 2.99%, but not now when it is more than double that.

For others it is a matter of avoiding a feared worst-case scenario of mortgage rates rising above 7.5%. To avoid this possibility some people will fix 3-5 years even knowing it is the wrong point in the cycle to do so.

If I were borrowing at the moment, I would take the pain of fixing for just one year.

I wouldn’t float because that is already more expensive and set to become more so as the Reserve Bank tightens monetary policy further. But such tightening is already factored into bank fixed borrowing costs for the 1-5 year periods.

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