Weekend Money: Cloud over borrowing

It may be too late to rethink your mortgage before the official cash rate review, reports Ann Cunninghame.

The dream run for mortgage rates has come to an end. Low and steady since last year, they're on the rise.

The Reserve Bank is expected to sanction the upturn in market rates on Wednesday week by lifting its official cash rate from 4.5 per cent to 5 per cent and even signal further rises through its Monetary Policy Statement.

The prospect of increased borrowing costs reopens for homeowners - current and prospective - the debate about fixed versus floating mortgages.

A flurry of increases in floating rate mortgages, kicked off a fortnight ago by Bank of New Zealand, has reminded homeowners not to take these rates for granted.

Floating rates had stuck at 6.5 per cent (for the trading banks) since late last year but now range 0.25 percentage points higher.

However, the likely official cash rate rise and accompanying Reserve Bank outlook could well bump them up still further.

ASB Bank economist Rozanna Wozniak says the general consensus is that the official cash rate is going up at the next review.

"Where people are divided is whether it's by 0.25 or 0.5 percentage points. I actually think that in the overall scheme of things it's neither here nor there," she says.

"What happens to the 90-day bank bill rate (and hence floating mortgage rates) really depends on the outlook for the next few months and what the Reserve Bank says in the text of its Monetary Policy Statement."

Rozanna Wozniak expects floating mortgage rates to peak around 9 per cent in late 2001/early 2002 but says the rises will be piecemeal, thanks to the stabilising effect of the official cash rate.

So, what should people do with their mortgage?

"It depends what sort of uncertainty they're willing to live with," she says.

"Personally, I'd probably be opting for one of those short-term fixed rates, say one year. If you think you're likely to want to make lump-sum repayments, put some on floating."

Bancorp economist Stuart Marshall says it's too late to act ahead of the official cash rate review, as markets have priced in the expected rise. He says floating and short-term fixed rates will keep rising next year because of the Reserve Bank's view on monetary policy.

"However, long-term mortgage rates are more influenced by inflation. If there's a Labour/Alliance Government, then those long-term rates are likely to go up too."

Mr Marshall himself has quarter of his loan on a floating rate and the rest fixed.

"The best advice, and certainly what a lot of New Zealanders have done, is go away from an all-or-nothing approach. If you're taking out a brand-new loan, I'd fix at least half.

"However, the first question is: how much can you afford? If the current fixed rate is absolutely the top, then don't take a risk. Fix."

Bank of New Zealand chief economist Tony Alexander is another mix-and-match man: at the moment, he is keen on a combination of two-year fixed (around 7.80 per cent) and floating.

He says that fixed portion offers some insurance against changes in floating rates at a reasonable cost, and it will also mature after he thinks both floating and fixed rates will peak.

Like Rozanna Wozniak, he expects floating rates to stop their rise around 9 per cent, but he thinks that will happen in early 2001. However, guessing rate moves is only part of the equation for homeowners. If you're likely to move house soon or have spare cash to pay back your mortgage, you won't want to lock into a fixed-term loan no matter how attractive.

Martin Shepherd, sales manager for property funding specialists Loan Plan, puts it bluntly.

"Fixed rates can be dangerous and, for a lot of people, they end up costing them money."

In general, he suggests taking out a fixed rate of no longer than one or two years and leaving some floating to reduce interest costs and allow lump-sum repayments.

"But I still believe that what people should do should be worked out on a case-by-case basis."

He also says a redraw facility can be the way to go. These are usually available as an option on standard floating mortgages and mean that if you pay in a lump sum or boost your repayments, you can get that extra money back later without any hassle. However, you cannot redraw your regular repayments.

That differs from a revolving credit facility, where you establish an approved level of borrowing and can usually borrow right back to that original amount.

The advantage is that you can run an all-in-one account and have spare cash reducing your mortgage interest bill, rather than earning peanuts in a savings account.

However, Mr Shepherd says these products suit people such as real estate agents or contract workers who are paid irregularly and "who may need the comfort of a giant overdraft," and perhaps also small-business owners or self-employed people who have variable cash-flow.

"For your typical mum, dad and two kids in their own home, it's totally unnecessary," he says.

"A redraw facility also takes the discipline out of managing a line of credit product."

Financial consultant and author Martin Hawes, in Five ways to save more money on your mortgage, says that it now suits most people to have two or more different mortgage facilities.

How you determine the split is critical: he says the key is to have as much of your loan as possible on the cheapest fixed rate, with just enough on a floating rate so you can repay debt with any extra income.

If that's all too difficult, you can take the approach suggested by Apex Mortgages general manager Kieran Trass. He calls it mortgage cost averaging and it involves splitting up your debt into lots of smaller loans, each maturing at different times.

Mr Trass says that averages out any interest rate moves and reduces the stress of deciding whether to fix or float.

The downside is that you can miss out on any special rates offered by lenders and you'll have to pay fees each time a fixed loan expires.

He says the usual advice to "fix some and float some" gives people flexibility and some certainty.

However, they may not realise that when they're close to the expiry date of the fixed portion, they're back to exposing their whole loan to interest rate moves.

* Ann Cunninghame is a freelance journalist. She writes regularly about mortgages for online financial publication
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