Where are fixed mortgage interest rates likely to average over the next 5-10 years?
This is a question people will be increasingly asking themselves soon as discussion grows about interest rates having peaked and thoughts turn to when they start falling and how quickly.
Already we have seen 3-5 year fixed rates come down 0.7% from their peaks in response to expectations that the Reserve Bank’s inflation fight will eventually be successful and they will be able to start cutting their official cash rate over 2024-25.
At this stage it is not possible to make any strong statements regarding how quickly interest rates go down. The uncertainties surrounding how quickly our economy grows, how much the labour market eases up, how much world inflation falls and so on are simply too great.
But we need some sort of a starting point and perhaps the best one is to consider where interest rates have averaged in the near past. If we simply calculate average rates over the past decade we find that the one-year fixed mortgage rate has averaged 4.4% since 2013 while the five year rate has averaged 5.4%. The other rates are spread out in between.
But I would not do this exercise.
The three year period from 2019 to 2021 was special in that mortgage rates were pushed to unsustainably and ultimately inflationary lows. In 2019 there were deep worries about deflation. Over 2020-21 worries about the pandemic and deliberately engineered excessive easing by the Reserve Bank pushed rates to new record lows.
So, I would exclude those three years from my calculations. Doing that we get the one year fixed rate averaging 5% since 2013, the five year rate 6.1% and the 2 – 4 year rates 5.1%, 5.4%, and 5.9% respectively. Those are the averages I would use.
We might feel inclined to lift these rates higher going forward because inflation may be underpinned to a greater degree than in the past by the costs of climate change, higher labour costs in China, some deinternationalisation of supply chains, etc. But we might decrease them a tad because of the high debts which people now need to take on board when they borrow to buy a house. We might also decrease them a tad because of the increased role being played by credit rationing using LVRs and, from next year, Debt to Income Ratios (DTIs).
Let’s just use these rates as they are, running from 5% to 6%.
At the moment one can fix 3-5 years at 5.99%. That would deliver what might be average rates for the four and five year terms over the coming equivalent periods. So, would I fix four or five years? After all, I’d be saving right away compared with fixing one year at 6.79% or two years at 6.49%. No.
I personally expect to see better long-term rates in one and two years time because of falling inflationary pressures. So, if I were borrowing at the moment I’d fix either one or two years and look to take advantage of those lower long-term rates somewhere down the road.
Do I see a return of the 2.99% five year rate of late-2020 to mid-2021?
No. That rate reflected excessive easing by the Reserve Bank combined with an excessively negative outlook for our economy by people because of the pandemic. But anything approaching 4% down the track would interest me.
Can we reasonably pick when long rates reach their lows?
No. And perhaps for some borrowers it doesn’t matter. As the data above show, the lowest average rate since 2013 and in fact since 2008 has been one year fixed. That has been the optimal rollover strategy. All you’ve got to do is have the intestinal fortitude to pay the cyclically high rates when they come along and not panic and fix long at exactly the wrong point of the fixed rate cycle. Good luck.
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