Rates go up and ... away

By MARK FRYER

Borrowers breathed easier last week when the Reserve Bank decreed that there was no need to increase interest rates - for now.

Floating mortgage rates stayed put and the housing market kept rolling along.

But whatever the Reserve Bank may decide, some mortgage rates are rising. And while nothing is inevitable about interest rates, borrowers and would-be borrowers should be prepared for more of the same.

So far, floating rates are much the same as they have been for the past few months - typically around 7 per cent if you're borrowing from one of the big banks.

However, fixed-rate mortgages have risen strongly.

Figures compiled by interest rate monitor www.interest.co.nz show that the average one-year fixed rate charged by the banks has risen from around 6.1 per cent in early July to 6.6 per cent now.

There have been sharper rises for longer-term loans - three-year rates have risen from about 6.3 per cent to 7.3 per cent or so over the same time.

Why are fixed rates rising while floating rates are more or less static? Because floating rates are decided largely by the Reserve Bank, rising and falling in line with changes in the bank's Official Cash Rate. And, for the past three months or so, the Reserve Bank has seen no need to change that rate.

However fixed rates, especially for longer terms, aren't much influenced by what happens in this country.

They respond to longer-term interest rates overseas, particularly in the United States. In turn, those rates depend largely on the health of overseas economies, especially the US, and on where the money markets expect rates to go over the next few years.

So, good news from abroad - or even the expectation of good news - is bad news for New Zealand borrowers looking for a cheaper long-term loan.

Lately, prospects for the US economy have begun to look much healthier, meaning New Zealand lenders have had to pay more when they borrow, and pass that cost on to their customers.

That rise has changed the relationship between fixed and floating rates.

Until recently, a prospective borrower who wanted a fixed-rate loan could have the best of both worlds: certainty and a rate which was lower than floating loans, by a healthy margin.

At the end of July, for example, even a five-year loan from one of the big banks could be had for 6.8 per cent, rather than paying 7.3 per cent for a floating rate. One-year fixed-rate loans were even more attractive - more than one percentage point cheaper than a variable rate deal.

Now, however, if you want the certainty of a fixed rate you may have to pay more for it. Three or five-year rates are more costly than floating rates, and while one-year loans remain cheaper, the margin has shrunk.

Just this week, several more banks lifted their fixed rates.

Floating loans may begin to follow suit, if and when the Reserve Bank decides it is time to start lifting rates.

When and by how much is a topic that has economists divided.

Many observers interpreted the Reserve Bank's latest statement on rates as suggesting that an increase in rates may not be far away, perhaps early next year or by the middle of the year.

The BNZ, for example, is forecasting that floating-rate mortgages are likely to start rising within six months and could be 1.5 percentage points higher than they are now in 2005.

Deutsche Bank, on the other hand, is forecasting that the Reserve Bank won't start raising rates until late next year.

Rising rates are not an exclusively New Zealand phenomenon.

Across the Tasman there are widespread predictions that the Reserve Bank of Australia will start raising rates later this year or early next year, and in Britain borrowers are being warned to expect to pay more (even if they can still get rates that look like a bargain - how about a two-year loan at less than 4 per cent?).

Higher rates aren't guaranteed. If the US economic recovery fails to last, for example, those recent rises in long-term rates could start heading in the opposite direction. But for now, the odds suggest that the trend is upwards.

As always, for borrowers the issue isn't just about trying to guess where mortgage rates are heading - something of a stab in the dark at the best of times.

What matters is to work out your priorities. If it's important to know that your payments won't change, fixed rates have a lot of appeal. For now, you can still have a year's worth of that security and pay less than you would on a floating rate.

If you want more security than that, you'll have to pay more than the floating rate for a longer-term fixed-rate loan. Even then, if floating rates do in fact rise next year, a three-year fixed-rate deal, for example, may look like a bargain.

But if flexibility is what matters most, and you can handle an increase in payments, you'll have to keep at least some of your loan on a floating rate and deal with whatever the future brings.

* To contact Personal Finance Editor Mark Fryer write to: Weekend Herald, PO Box 32, Auckland. Email: Email Mark Fryer. Ph: (09) 373-6400 ext 8833. Fax: (09) 373-6423.