Jumping off the short-term interest rate bandwagon

While borrowers have flocked to floating to one year fixed term home loan rates over the past year in anticipation of interest rate cuts one mortgage broker urges his clients to think about the ramifications carefully.

RBNZ data show of the total $7.6 billion residential lending in November, 47.4% was taken out by borrowers on floating interest rates.

Campbell Hastie of Hastie Mortgages says while it is tempting to look at the shorter term rates they do cost.

The major banks’ floating interest rates are in the 7.25-7.45% range and in the case of TSB 8.19% compared to 5.49-5.59% for a two-year fixed rate.

Hastie says he is not telling all clients to steer away from floating rates, but he is pointing out that when they get past looking at their own circumstances they need to ask whether the new interest rate they are hoping to get is going to drop enough to make it worthwhile.
“Various market commentators have consistently advocated for people to fix for six months, anticipating swift interest rate falls. Their logic seems sound – fix short, then capitalise on better rates at your next fixing. But the same commentators haven’t changed their tune over the past six months, maintaining their “fix short” mantra despite evolving market conditions.”

He says the market is at a point where it is not worth paying the floating or six-month rate because he doesn’t see the longer-term rates are going to drop sufficiently to justify that. “The two-year and longer fixed term rates have bottomed out.”

Substantial punt

Why? For the six-month strategy to work, rates need to drop significantly in a short period.

For example, a $100,000 loan with a March 2024 refix date and a 12-month fixed term, total interest costs would have been $6,890. However, for six months, with the next refix due in September 2024, total interest costs over the same 12 month period would have been $7,020.

Hastie says the $130 difference over 12 months might be considered peanuts. “For a $100,000 loan, it’s a small amount and might be worth the punt since the result could have been different.

“Here’s where it gets interesting, however: To break even on the six month strategy, the six-month rate would have needed to fall to 6.59% by September. For the gamble to actually pay off, rates would needed to have dropped even further to at least 6.49%. As it turns out, 6.49% has arrived, but it took another two months to show up – in November 2024, not September 2024.”

This becomes even more significant when many borrowers have mortgages ranging from $500,000 to $1 million. “For these borrowers, that small $130 difference suddenly becomes $650 to $1,300 – a much more substantial sum that makes “taking a punt” considerably harder to swallow,” Hastie says.

Still on the way down

Multiple interest rate reductions are still predicted for the first half of this year but Hastie says they will be gradual and are unlikely to return rates to the lows of the pandemic.

“The interest rate curve is now behaving the way it has in the past. It has a similar spread of rates that were seen five or six years ago. It is shaped like the Nike tick with the six- and 12-month rates at the short end of the tick and the two, three, four and five-year rates at the bottom end and rising away.  That is the shape of the curve we have historically had.”

Although there is a segment of borrowers who are always prepared to take a punt and pay a higher interest rate on the chance of getting a better rates in six months’ time, Hastie doesn’t think it is worth it.

Instead, he says borrowers are better off with a strategy that includes a mortgage split that has a different fixed rate expiry in each half.

“For a lot of borrowers that is the way to manage interest rate risk and they are discovering that floating or even a six month rate is not the way to go.”

This new reality requires a different approach to mortgage strategy, he says.

While bank stress test rates have declined, increasing borrowing capacity for many, the focus should be on sustainable, long-term planning rather than chasing the lowest possible rate.