Mortgage rates still yet to peak

Mortgage rates still yet to peak

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An analyst was quoted in the media recently as saying she believes fixed mortgage rates are already at their peaks. I can see where she is coming from, but borrowers should contain their excitement for a while longer because the chances are quite strong that further rises will come.

Let’s start with the once extremely popular one year fixed mortgage rate.

This rate was as low as 2.19% in the middle of 2021 but is now near 4%. My belief is that it will rise to close to 5.5% on the back of two things happening.

First, the Reserve Bank will tighten monetary policy and take the official cash rate from the current 1.0% to about 3%. The rate was just 0.25% in the early part of October, so the tightening cycle is not yet one-third of the way through.

Expectations of the cash rate continuing to rise over the coming year have pushed the one-year swap rate from 0.4% last year to near 2.8% currently. This swap rate is best thought of as the cost to a New Zealand bank of borrowing money to lend at a fixed rate for a one-year period. The rate is heavily affected by where the official cash rate sits now and where it is expected to be in a year’s time.

The 2.4% rise leaves at least 0.5% upside. But if you compare the difference between the swap rate and the one year fixed mortgage rate a year ago and now, you will see that the margin earned by the bank has actually fallen from near 1.8% to 1.2%. From that margin banks must pay their other costs such as staff wages, property costs, and so on.

This is the second reason why further upside for the one year mortgage rate remains.

Bank margins are low. In fact, the current 1.2% margin is about 0.8% below the margin for the past five years. Add that 0.8% to the 0.5% upside left for the swap rate and you get my prediction of the one year mortgage rate reaching close to 5.5%.

I can run the same exercise for other terms and perhaps it is more the likes of the three to five year fixed mortgage rate which the analyst was referring to. The three year mortgage rate has risen from 2.65% last year to near 4.8% now. But that latest rate gives a margin which again is 0.8% below the average for the past two years.

Add in upward revisions happening right now to global inflation forecasts for the next few years as internationalisation pulls back and therefore productivity growth slows, and we get potential for the three year fixed rate to go higher. Maybe to around 6%.

A lot will come down to the degree of competition between lenders – something which is impossible to forecast.

Will some borrowers struggle if mortgage rates exceed 6%?

Yes. But that will reflect something special about their personal circumstances, not something relevant to the majority of borrowers. That is because everyone who has taken out a mortgage over the past few years has had to show their bank that they could service a mortgage rate of at least 6.5%. Many had to prove ability to service up to 8% heading into late-2019.

Many borrowers will have to cut back on spending in other areas in order to meet their mortgage payments. Some will take on extra work which appears to be readily available. Some will take in a boarder. Again, this is something many will be able to easily do because of the ongoing shortage of rental accommodation in many parts of the country.

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