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Bernard Hickey looks at how to think about whether to fix or float and what bank economists are saying about interest rates and house prices

Bernard Hickey looks at how to think about whether to fix or float and what bank economists are saying about interest rates and house prices
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By Bernard Hickey

The Reserve Bank is expected to hike the Official Cash Rate for a third time in three months on Thursday, which should force borrowers to revisit the age-old question of whether to fix or float.

Banks have also sharpened their fixed mortgage rates in recent weeks, making the fixed vs floating decision even more interesting. Banks have much lower profit margins on fixed mortgages and have been able to borrow cheaply on international markets.

That is making fixing rather than floating increasingly attractive for those calculating what is purely the cheapest deal. See the table below for the latest calculations on a NZ$500,000 mortgage.

The answer depends on the interest rates being offered, your outlook for interest rates and your personal situation. A combination of both floating and fixed may also work, particularly if you want to be able to be more flexible in how you pay off your mortgage. It may also make sense to fix short term rather rather than longer.

A flat-to-falling OCR makes floating more attractive, while a fast-rising OCR makes fixing and fixing for a longer time more attractive.

It all depends on whether actual interest rate increases are close to the forecast track laid out by the Reserve Bank and expected by the financial markets. That's because fixed mortgage rates are heavily based on the 'swap' rates in wholesale markets and those 'swap' rates are dependent on those market expectations for future interest rates.

If interest rates move as expected then there's often not as much benefit in fixing as you might think.

The main benefits come from the banks accepting a lower 'profit' margin on fixed mortgages than advertised floating mortgage rates. Sometimes a floating rate borrower can get a better deal than a fixed mortgage simply by directly challenging your bank or working with a broker to challenge the bank to offer a better floating deal than the advertised deal.

But there is a way to work out which deal is cheaper over the full term of a mortgage. Interest.co.nz has a calculator that allows you to compare the costs of fixed vs floating over the full term, remembering that often the floating rate is cheaper in the first few months than a fixed rate, but then more expensive later in the term.

It's the total benefit that's important over the term of the mortgage and also whether rates actually rise faster or slower than the expected track built into your fixed rate mortgage.

Here's a table that shows the benefits of moving a NZ$500,000 mortgage from a floating rate of 6.5% (likely after June 12) to the various fixed options, assuming different interest rate tracks. The gains are indicated as a positive and the losses are negative. The middle track for the OCR is in line with market expectations.

The latest estimates, given the sharp drop in fixed rates in recent weeks, suggest fixing is cheaper than floating across the board.

OCR rate by end of 2016 One year fixed (5.85%) Two year fixed (5.85%)
OCR at 4.25% (low) + NZ$1,853 + NZ$5,007
OCR at 4.75% (middle) + NZ$4,775 + NZ$7,929
OCR at 5.3% (high) + NZ$7.982 + NZ$11,136

What the bank economists say

Bank of New Zealand Chief Economist Tony Alexander argued in his June 5 weekly summary that he would look to fix most of a mortgage for three years. He pointed out how recent falls in long term wholesale borrowing costs in the United States had fed through into low long term funding costs. He also saw house price gains in 2014 that spread out from Auckland and Christchurch.

That has prompted banks to shift some of their point of competitive focus away from the short term fixed rates to medium to long term ones. The result is falls in those rates great enough that were I borrowing now I would hop out of floating and either fix for three years at 6.25% or four years at 6.59%.

After all, next week we expect the RBNZ to raise the cash rate another 0.25% and that will take floating rates to near 6.5%. Basically, unless you believe that the world is set for a new economic plunge or we are about to have a foot and mouth outbreak, fixing three years and beyond now appears optimal.

ASB's Economists Nick Tuffley and Chris Tennent-Brown wrote in this April 29 Home Loan Rate Report they think the OCR is likely to peak around 4.5%, which is lower than the Reserve Bank is forecasting, and that rolling short term fixed rates are cheapest.

The RBNZ has lifted the OCR at two consecutive meetings, and another increase looks likely when the Bank meets again in June. Accordingly, floating mortgage rates and short-term fixed rates are likely lift again soon. If borrowers have not reviewed their situation already, now is definitely the time to give it some thought and look at strategies to manage higher borrowing costs over future years.

We stress that if the RBNZ hikes more aggressively than we expect (i.e. more hikes early on in the cycle), or lifts the OCR higher than 4.5%, then these shorter- term rates will lift more than we are forecasting, making this strategy more expensive than the longer-term rates on offer today.
By 2016 we would expect the variable rate to be around 8.25%, and fixed-term rates to be up around 8% too, rather than the 7-7.5% level we are currently forecasting. A key thought is that fixing for longer terms now does give extra insurance against stronger OCR increases than we are expecting. Depending on borrowers’ risk appetite, that insurance may be worth taking. In this vein, the cost of some certainty is not actually too high, based on current mortgage rates. This is perhaps easiest illustrated with another example: The current floating rate is 6%.
If the RBNZ lifts the OCR again in April, then say again in July (as we are forecasting), the floating rate will most likely lift to around 6.25% in April, then 6.5% soon after the subsequent hike in July. A borrower can fix a 2-year mortgage for a carded rate of 6.29% right now. In other words, a borrower can lock in now a rate that is in line with what we expect the floating rate to be very soon, and lower than what we expect floating rates to cost around the middle of this year.

Tuffley said in this May 13 housing confidence report he expected house price inflation to ease through 2014.

We are seeing very early signs of easing demand and supply increases. And it appears that the peak period of house price gains is behind us. Price gains are still expected this year, but the rate of house price appreciation is likely to be lower in 2014 than it was in 2013.

Westpac's economists said in this June 9 weekly commentary the current 2-3 year fixed rate specials offered good value and there was the prospect of a second wind for the housing market if the Reserve Bank didn't move to keep rates expectations high..

The standard fixed rates from around six months to three years appear to offer similar value, and are a fair reflection of where we think shorter-term rates are going to go over the next few years. However, there are a number of specials currently on offer, particularly for 2-3 year fixed terms, that are substantially below our expectation for short-term rates over those horizons.

Fixed rates are more likely to rise than fall over the next few months, so for those who are looking to fix there is little to gain from waiting. Fixing for four or five years may result in higher interest payments over the life of the loan than opting for shorter-term fixed rates.

However, these longer-term fixed rates may still be preferred by those who are willing to pay for certainty. Floating mortgage rates usually work out to be more expensive for borrowers than short-term fixed rates, such as the six month rate. However, floating may still be the preferred option for those who require flexibility in their repayments.

We regard the recent drop in mortgage rates – the average 2-year rate has fallen 34 basis points in two months – as particularly significant. Along with the uplift in migration, it raises the possibility that the housing market could see a second wind, a prospect that the RBNZ would regard as very unwelcome.
So even if the balance of developments justifies a slightly less anxious tone about inflation than in the March MPS, and a slightly lower 90-day rate forecast, we expect the Reserve Bank will also want to prod errant financial markets into lifting two or three year swap rates

ANZ Economists said in their May 30 Property Focus their analysis indicated a two year rate was most attractive.

ANZ’s carded mortgage rates have seen a number of changes in the past month, with the bellwether 2 and 3 year fixed rates falling as competition in the mortgage market heats up, while shorter-dated fixed rates continue to lift in line with a higher OCR.

Borrowers with at least 20% equity will find it hard to go past the 2 year fixed rate special of 5.85%, which is back to December levels and now close to the cheapest rate on the curve. Breakeven analysis suggests there is lesser value in fixing for longer terms of 4-5 years, with these rates already higher in anticipation of the RBNZ tightening cycle.

They also said Auckland's housing supply shortages may not be as great as others fear, which raised the prospect that rents may have to rise or prices fall.

One of the peculiarities about Auckland’s housing issues has been the disconnect between the shortage thesis and lack of movement in dwelling rents. According to the March 2014 CPI, the annual increase in Auckland dwelling rents was 2.3%, not much above that of the 2% nationwide average and half the 4.9% rise in Canterbury.

Other motives, including the focus on capital gain, may be behind small movements in rents, but with rental yields in the Auckland residential market (around 4% according to our estimates) already very low in relation to (rising) interest costs, something has to give. Either rents move up more sharply or prices fall.

Mortgage rates

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48 Comments

If inflation was 1.5% early this year while the OCR was 2.5 then once the OCR is 4.0 then inflation could be 0.5%, then rates can be cut. So maybe 6 months or floating  might be best. 

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I will stay floating. NZ is one of the only countries raising interest rates. The European central bank has just reduced them to 0.15%. All  this does is make the banks more profit to sent to Australia, and leaves most Kiwi borrowers with less money in their pockets to spend on the Economy. Rates wioll be forced down later part of this year.

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I will stay floating. NZ is one of the only countries raising interest rates. The European central bank has just reduced them to 0.15%. All  this does is make the banks more profit to sent to Australia, and leaves most Kiwi borrowers with less money in their pockets to spend on the Economy. Rates wioll be forced down later part of this year.

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Tend to agree with this strategy.  The RBNZ and banks may soon realise that NZ is in a more precarious state than their spreadsheets are telling them. We could be into recession sooner than intended, & bank borrowing is slowing. 

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Engineer - please explain how banks make more profit if you have fixed your mortgage?

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Banks currently have a specific strategy of locking in customers with tempting fixed rates. They then have a higher retention rate of customers. The greater the percentage of customers that float, the greater number will change banks.  So an indirect increase in profit due to a higher retention rate. 

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But how does the banking industry make more money from mortgage holders fixing their loans? ...the industry....even if one banks has a greater portion of fixed mortgages they may well have paid a price of lower margins to achieve it, and besides they all run the same strategies so that's a zero sum game. Short  answer is, they don't make more money, in fact banks don't really care what you do except they do care whenever there is an excessive rise in rates and they get a deterioration in the credit quality of their borrowers who have remained floating and a increased in capital provision they have to make against that.

 

One mistake most make, and surprisingly Bernard is again a grand example of it here, is that NOONE, not a commentor, a blogger, not English, Wheeler, Yellen, NOONE, knows what will happen to rates over the next few years. With 5yrs plus of negative real interest rates, massive asset purchases from central banks, forward guidance etc there is a massive distortion of normal market signals I.e. You can't know where it's going when you don't really know where you are now. Fixed rates are purely about risk management, pure and simple, and the ones that try to work out the "value" of a fix rate compared to their facts deprived opinion about where the floating rate will go, are the ones most delusional - some were even adamant that we would get two interest rate cuts last year and so far are about to be 5 hikes above that from Thursday.

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Recruit, Retain & Repeat  -  the 3 R's of marketing.

It is very important to retain your customers. Once a mortgage borrower is fixed then it is difficult & expensive for them to break the term & change. Although a percentage will be forced to do this due to changed circumstances such as moving jobs, cities, house upgrades etc.

It is far more expensive to gain 1 new customer than to retain an existing customer.

If banks don't care what you do, then why are they currently spending millions on outbound call centre staff who are persuading and encouraging customers about to end a fixed rate period to re-fix? 

Yes, I agree floating customers are not getting the true benefit of the "float" - mainly because banks do not really compete on the floating rate - so there's not much competion in the floating space.  But floating or short-term customers do retain some leverage - they can walk if they want to without cost  -  or even with some nice incentives from the competition currently.

 

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Of course banks want to retain customers, but totally irrelevant to the point Engineer was making - he wasn't thinking retention, but happy for him to say differently and explain his thinking. I have never understood your logic MB that seems to suggest, if the market goes up more than I think (let's just for a moment think there's a possibility you don't know anything special that the market doesn't already know), it's still best that I get screwed floating because I can always threaten to transfer to another bank and continued to get screwed by the rise of the floating rate there too. It's not a competition between you and the banks, it's risk management...google it.

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Over a 20 year term -  floating/6 month actually beats fixing medium/long.
A good percentage of NZ-ers got caught fixing long-term in 2006-2008, & then broke their fixed rate at considerable cost to access the new lower rates.

Can you answer the question?  If banks don't care what you do, then why are they currently spending a lot on outbound call centre staff who are persuading and encouraging customers about to end a fixed rate period to re-fix?

Sure, fixing solves one risk aspect.  However, it opens another risk -  of being stuck on a relatively high rate while we hit GFCII and rates plummet again.

 

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It totally depends on what rates do and what you fixed at.  I don't see how you can make a generalisation that floatign is alway cheaper, it depends on individual circumstances.

 

Sure with hindsight, people regret fixing when rates go down.  But what if rates had gone up even further?  Fixing in that senario for many people will be the difference between struggling along or foreclosure.

Likewise with hindsight, allot of people regret not fixing when rates go up.  Floating gives you uncertaintainty, and a risk off paying more if rates go up.  Fixed gives you certainty and a risk off paying more if rates go down.

Can you tell me, over the next 20 years, how often will rates rise faster than medium term market expectations, and how long will they fall faster than expectations?

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How does BNZ retaining a customer instead of them moving to ANZ, send more dividends to australia?  The net effect is zero.  

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Your'e just repeating the same stuff MB and ignoring what comes back so let's forget it. But I do find it interesting that despite your recent history on the subject you are certain of what will happen.. It might, it might not, indeed you could be 100% wrong, but you clearly do not believe my statement that literally no one in the world knows - you think at least one does. Good luck to you.

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GA - I believe your statement that no one can predict the future (of interest rates, inflation, GDP, global events etc ).   That is why it pays to be careful not to follow conventional wisdom & the herd.    Who would have predicted in 2004 that OCR would hit 8.25 by 2008  Or in 2006 who would have predicted the OCR would be slashed to 3?  

Many home owners were hitting the wall by 2008/2009 through very high interest rates. The GFC and the chch earthquake saved them.  Have we learned anything from that policy setting?

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Thank God for that then, that makes it easy for you. The last RBNZ figures I saw a few months ago said that 74% of NZ mortgage holders were either floating or fixed for less than 12months (i.e. Basically floating). I understand that's now in the high 60%'s, so if the herds always wrong (and yes it most often is - hedged long at the top because long is cheapest with a negative yield curve then, and floating/short at the bottom when that's always cheapest with a positive yield curve), you know exactly what you need to do not to run with the herd - good on you MB - it would have been better last yr, but it's never too late to manage risk and doff your hat to the herd.

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Quoting BH:   'If interest rates move as expected then there's often not as much benefit in fixing as you might think."

 

 
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MB - read my post about Bernard at 8.25pm, he fails to understand that a fixed rate is. It's the markets expectation as to where the floating rate will average over the period, which means yes if the market is miraculously right, you'd pay exactly the same whether you floated or fixed. So what's point of fixing ? Risk  management!  Risk management ! Risk management ! Believe it or not but the market as well as individuals gets it wrong to. You seem to think on the one hand you can beat the market with greater insight, and then on the other, you can't, so do nothing - just let it play out and hope for the best. The good thing about that approach MB, is you'll feel more comfortable with lot of company, but then, we've already talked about the herd.

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Can you answer the question?  If banks don't care what you do, then why are they currently spending a lot on outbound call centre staff who are persuading and encouraging customers about to end a fixed rate period to re-fix?

it must be in their interest (excuse the pun) to have their borrowers fixed. 

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I clearely stated that retention was an obvious strategy for any bank to employ (get them to refix) but I'll repost the post  since you seem to ignore what doesn't suit you argument such as my last post last night.

"Of course banks want to retain customers, but totally irrelevant to the point Engineer was making - he wasn't thinking retention, but happy for him to say differently and explain his thinking. I have never understood your logic MB that seems to suggest, if the market goes up more than I think (let's just for a moment think there's a possibility you don't know anything special that the market doesn't already know), it's still best that I get screwed floating because I can always threaten to transfer to another bank and continued to get screwed by the rise of the floating rate there too. It's not a competition between you and the banks, it's risk management...google it."

Try and remember what the thread was about, Emgineers's comments that higher rates mean higher profits for banks which is clearly wrong. Running off on tangents about obvious tactics such as banks offering to  refix mortgage rates for retention purposes is totally irrelevant to the subject 

 

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So  finally we have an admission that banks do want their mortgage borrowers to fix thei loan. And also an agreement that retention is a key strategy of a bank. 

Previously there was an implication that banks would prefer customers to float (due to greater margin). That implication is clearly wrong - demonstrated by intensive campaigns currently to attract customers to fix. 

 

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Only if other banks do otherwise why would they care.....and what has that got to do with the topic MB ?- as usual you run off on any tangent you can find as a reason to not fix your loan risk. as if youre in some way your gaminmg the banks - its frankly pathetic. You are your own worst enermy (and now the equivalent of five rate hikes wrong and still lecturing me). The banks aren't out to GET you...stop focusing on what banks want for their businesses, focus on risk what the market could or couldn't do to you. The market, economy, and RBNZ will determine what you pay, not banks !

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In terms of risk management then,

a) fixing only makes sense if you think the OCR will go a lot higher than everyone else. That right now would be a strange call IMHO.

b) stay floating which means about NET and you are flexible, no loss, no gain.

c) Float because you think its going to drop, if it does you profit. The opposite would be a steep rise when you lose, but really given the world is a mess and getting wore I cant see how that will occur.

regards

 

 

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Only partly right in my view Steven.

a) not higher than everyone else, just higher than the market is currently pricing in at that time. Currently it's still pricing in less than the RBNZ Is forecasting (rightly or wrongly), but less so after today and the move up in rates closer to the RBNZs

 

b& c make a big assumption i.e. that someone actually knows whether forecasts are right or wrong. But it's clear, no one does, so on that basis it could go higher, it could go lower. Lower and floating is good, higher and floating is screwed. On the basis that no one knows that, the art is to find what the "neutral" interest rate position is for you (25%, 50%, 75%, 100% fixed), but it's rarely 100% fixed or floating for the vast majority if they really understand the risks and the fact that no one knows. An assumption that rates could not get cut later is denying a number of negative market risks, likewise an assumption that they couldn't go higher than 5% denies the simple fact that after 5yrs of negative real interest rates, massive assets purchases, forward guidance etc there are massive distorted market signals that ensures no one knows the real value of assets, the longer-term consequences of massive QE, the long-term inflationary impact etc - where are we at, we just don't know. Instead they dismiss any such suggestion and in doing so are effectively saying "I am privy to formation that markets are not aware of"- clearly naive.

 

Your approach as described is a common attitude in here, they express a viewpoint then seem to suggest they are beating the house 100% on that view - that approach has been found to be totally dumb whenever reverted to by professionals, and criminally neglectful by amatuers (I.e. the public).

 

 

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MB

 

What is the banks' average margin on a floating mortage ?

What is the banks' average margin on a 2 year fixed mortage ?

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From your questions Spottie, I assume you are implying that banks prefer their borrowers to be on floating as the margins are greater. 

However, there is clear evidence from personal marketing campaigns that they are persuading customers to fix on,say, 2 years. 

Can you explain the reasons for this? Maybe it's more than seeking retention. 

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Do you know what those two margins or not ?

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I recently opened a 2 year term PIE.

5.20%; interest compounding monthly.

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I do laugh at your weak attempts at a strawman argument.

 

First off it's a comment on compounding periods.

When unable to counter my comment you veer of into something completely different.

 

A clear sign of one with a weak argument.

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No.

Compounding monthly.....luvly jubbly.

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"annual record profits on top of previous years record profits for doing absolutely nothing."

 

kimy

What is the average return on equity for our banks ?

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"Higher than you can think"

 

How do you know?

Give me the figure of ROE, and I will tell you whether it is higher than I think.

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Let me anwser that for you Spottie...about 15%, about in the middle of the pack of returns on the top 100 NZX..i.e. average

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Thank you Grant A.

 

I can see kimy spitting out his coffee over the keyboard now in indignation.

 

How dare the banks have an average ROE.....outrageous !!

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So, what is the figure then ?

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So, what is the ROE figure then ?

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In your case Kimmy, you couldn't pay me enough to suffer your credit risk - poor bank risking its capital on you.

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The RBNZ will hike the OCR rates, and the banks will try to lure customers to fix thier mortgages. Once the rates fall (as per ther rest of the world), customers that have fixed will want to break their fixed mortgages and will have to pay high break fees. The banks prefer customers that have fixed rate mortgages and they are locked in at that rate and locked to the bank.

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Engineer do you actually understand that banks lay off most, if not all, of their fixed rate risk - if rates fall later the ones smiling are the investors to whom that risk has been laid off to ?. If they keep rising the ones with the opportunity loss are the investors, and the ones smiling are the borrowers. The banks make their margin for accepting the credit risk on the borrower and frankly have little interest in what happens to rates after the tranasction is dealt. As Mortgage Belt repeatedly piointed out the obvious, banks are happy to hab\ve custoemrs with fixed rates lockign them (somewaht) to that bank, but they don't care a bugger about it in terms of rate level they get it at - at 5% or 7%, they still get their margin, a margin dictated to by the competition at the time they transacted it

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I don not see many smiling borrowers here in NZ. If you can arrange a mortgage offshore then the borrower would be smiling, as the rates are realistic with the world situation. And NZ is part of the world is it not.

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And what happens if the exchange rate drops?  Allot of unhappy mortgage borrowers in Iceland who had offshore mortgages.

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I don not see many smiling borrowers here in NZ

 

I know some.

They fixed 12 months ago for 4 and 5 years.

DESPITE what some posters say here that they were falling into a trap set by the banks.

 

There are NZ banks who will do a mortgage in a foreign currency.

Go and apply, IF you want to take the rate of exchange risk.

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Yup but if you were in Europe you'd also have deflation, 25% unemployment, bank ready to fall over, debt to GDP of over 100%, pensions being cut, services being hacked etc ....what else of theirs do you want ? Get real

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fix, Fix, FIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIX!!!!!

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So kimy.

You say the banks' ROE is way too high.

However you don't know what the actual figure is.

 

Let's put the question another way.

What percentage figure would you like to see the banks' ROE reduced to ?

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I am glad banks make healthy profits. So should everyone else be.

It means any money people deposit with them is safe. It means if we want to go to them and borrow money to invest they will have money to lend.

Profitable banks are good for the economy.

PS... no I do not nor never have worked for a bank and yes I am very much a net borrower from banks.

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So I guess you will still be singing their praises when they take away your property in a downturn?  or when your quality tenants move, only to be replaced by those who trash your place while not paying the rent?  Will the bank give you sympathy? 

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It's no wonder you are a renter.

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