Mortgage interest rates are set to rise

Man rock climbing

Those of us who have been around for a few years and seen a number of housing and interest rate cycles might not be the best people for young people to speak with as they seek understanding about where interest rates might go in the next few years.

Since 1992 when inflation fell from an 11% average over the 1970s and 1980s to just 2% since then, and interest rates fell away firmly, our memories have been strong of the bad old days of mortgage rates above 20% in the late-1980s. They were then close to 11% in 1998 and again in 2008 just before our economy was struck by the Global Financial Crisis.

The inflation effect

I well recall the many comments from people during the 1990s along the lines of our Reserve Bank eventually having to let inflation settle back at 5% and how those forecasts were wrong every single time. That in fact is one of the legacies of the fight against inflation of the 1980s. Central banks learnt that if they show they are prepared to do whatever it takes to get inflation back under control then eventually people stop expecting inflation to be high and it settles down.

In the field of economics, it is those expectations which matter more than what the inflation right is actually doing. That is why the printing of money around the world has failed to generate inflation. People have not expected that inflation will soar, so they have not rushed out to spend their money as soon as they have received it.

At the moment we can see inflation rates rising in many countries as supply chain problems have pushed up costs of many things, and as people have rushed back into certain activities as their vaccination programmes have progressed. This has placed pressure on limited resources in the likes of the hospitality sectors in the United States and United Kingdom.

But the inflation hits for the moment are temporary, and as yet there is no firm evidence that people are lifting their inflation expectations appreciably higher and starting to talk as people did in the 1990s about low inflation disappearing and the bad days coming back again – so buy now before prices go higher!

This is important

As long as the general debate continues to revolve around these rises in many prices being temporary, or one-offs, our central bank is unlikely to feel the need to issue one of its warnings from earlier years regarding being prepared to do whatever is needed to get inflation under control.

Nonetheless, borrowers should not anticipate that the current record low interest rates will continue much beyond the end of this year. We can see strong growth starting to appear in some – not all – economies of relevance to us such as the UK, Australia, United States and China. At some stage central banks are going to feel that their economies no longer need extraordinary stimulus from the lowest borrowing costs people have ever seen. They will start to take the sugar away.

When should we expect things to change?

In New Zealand the current general expectation is that this removal of the sugar bowl will commence in the second half of next year. One or two forecasters are suggesting the first half. For borrowers the key message is this. Your bank works out your ability to service a mortgage at an interest rate some 3% higher than what you are actually paying at the moment for a very good reason.

They know interest rates will eventually rise, and while they may not know when, at what speed, and to what extent, they do know they want all their customers to be able to service the higher payments when they become necessary.

So, run your own cash flow exercise examining what you will alter spending on if interest rates do happen to rise some 2% from the second half of 2022 as seems to be a reasonable expectation.

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