There's more to mortgage rates than fixed and floating. Photo / File
Those who have been around a while have lived with standard bank interest rates of 20 per cent and higher, so they view the recent long run of sub-7 per cent mortgage rates with pleasure.
They know that there is always the potential for mortgage rates to rise, given the right conditions, and factor this into all their investment decisions. But anyone entering the mortgage market for the first time since the turn of the century could be forgiven for thinking that rates move up and down just a few percentage points year on year, that things move along sedately.
True, not a lot changed between 2008 and 2014 as the Reserve Bank (RBNZ) battled the effects of the Global Financial Crisis (GFC).
The official cash rate (OCR) sat at 8.25 per cent for a year from July 2007 before falling to a record low of 2.5 per cent in April 2009, staying there until the latest round of increases began in March this year (apart from a six-month blip at 3 per cent from July 2010).
The RBNZ sets the OCR, which in turn sets the tone for bank mortgage interest rates. The main trading banks typically set their rates close to the OCR.
Nick Tuffley, chief economist at ASB Bank, expects the RBNZ to pause any OCR rises until December, recommencing with a far more gradual tightening cycle than seen in recent months.
"We expect the second phase of the tightening cycle will take the OCR to a peak of 4.5 per cent in the second half of 2015," says Tuffley.
"So in the short term there will be some respite from higher mortgage rates, but in time rates will rise further."
He is predicting mortgage rate increases will be greatest for rates of up to two years' maturity.
These terms will reflect steadily the effect of the rising OCR.
In contrast, longer-term rates don't have so far to move as their time periods mean that for some time they have been increasingly factoring in the tightening cycle. Longer-term rates are already largely pricing in the expected OCR increases, so if you fixed your rates you are paying up front for those likely interest rate rises.
"Our peak OCR forecast implies the variable mortgage rate will reach about 7.75 per cent [reflecting a fairly direct transmission of the 1 per cent of expected OCR hikes].
"We expect short-term fixed rates to eventually settle near 7 per cent and the five-year rate to settle between 7.5 and 8 per cent."
Tuffley says there are a number of things to consider when assessing the likely path for interest rates in order to secure a mortgage that matches your profile. "Firstly, floating rates are not the cheapest rates right now - the six-month rate is. So borrowers can create some certainty, and obtain a lower rate than floating, by fixing for short terms.
"In fact, many of the carded rates at the main banks out to about 36 months are lower than floating rates right now.
"Secondly, all fixed rates are still below their long-run (10-year) average. So by this simple measure, the fixed terms are reasonable value."
Assuming the RBNZ doesn't lift the OCR any higher than 4.5 per cent, he says rolling short terms such as six-month or 12-month appear a cheaper strategy than locking in the longer terms such as the four-year to five-year rates.
"But if the RBNZ was to lift the OCR more aggressively than we expect, then longer terms would likely be cheaper. For example, a two-year term would offer more protection against higher than expected interest rates, without having to pay a dramatically higher rate than shorter-term rates. "Borrowers need to think about the trade-off that works for them between the certainty of fixing against the loss of flexibility you get from fixing and any premium you effectively pay for getting that certainty."
Human nature compels us to opt for mortgage rates we shouldn't be on, says Loan Market mortgage broker Bruce Patten. Cassandra Mason talks to him about what we can do differently.
How many Kiwi homeowners are on a mortgage rate that's not right for them?
Nine out of 10 people do the opposite of what they should when it comes to interest rates, Patten says.
"When rates are at their lowest, they take the cheapest rate for the shortest term. When rates are at their highest, they take the cheapest rate for the longest term."
In 2008, people were fixing at 8.5 per cent for five years because they thought rates were going to keep rising and hit 20 per cent.
"They always go for the cheapest when generally that's the opposite of what you should be doing.
"When rates are at their lowest, you should be going for a longer term and when rates are at their highest you should be going for a shorter term because inevitably when they're at their highest they're going to come down, and when they're at their lowest they're going to go up."
Human nature spurs us to go for the cheapest rate, not necessarily the best rate.
What are the trends following the recent interest rate increases?
Patten says a "huge" percentage of mortgage holders are still on a floating interest rate but they're rapidly moving to fixed.
While about 60 per cent had been on a floating rate prior to the latest hikes, that was down to about 40 per cent. A large portion of the market got "sucked into" cheap, one-year fixed terms when there was an expectation rates were going to start increasing - terms that would soon be ending.
"It's typical ... seeing that rate below 5 per cent was very appealing and without that forethought of 'Where might things be in a year's time?'."
Many of those on low cost short-term rates would be bumped up from 4.99 to 6 per cent once their one-year terms were over.
On some loans, that could mean hundreds of dollars extra a week. "It's going to put a lot of pressure on."
"Why not take a three-year term and know that you've got stability for some time to come?" Patten asks.
While three years won't suit absolutely everyone, 90 per cent of mortgage holders live week to week, so it's crucial they know what their costs are well ahead of time.
"We've had a 1 per cent increase in the OCR, we're expecting that early next year we'll have another 1 per cent increase."
People panic about interest rates going up, but are reluctant to believe it's happening until it does. "We were saying to people last December 'Now's a good time to fix, rates will go up after Christmas,' but inevitably, the busiest time was when the [OCR] announcement was made in March."
How hard is it to change rates?
Patten says it's "relatively easy" to switch rates.
"If rates are going up and you are on a low rate, generally it doesn't cost you anything to change and a lot of people don't realise that."
People tend to think they'll be penalised, but this would only be the case if rates were dropping and mortgage holders wanted to switch to a lower rate.
The OCR is expected to enjoy a hiatus from hikes for the rest of the year, so now is a good time to be reviewing what rate you're on.