Why the cuts in 5 year mortgage rates won't be enough to fire up the housing market

By Bernard Hickey

A bevy of banks surprised home owners and regulators in the last two weeks when they slashed their long term mortgage rates by as much as 0.75%.

But is it enough to transform the housing market in the same way that the mortgage price wars of 2004 and 2006 confounded the Reserve Bank and fired up the economy back then? The simple answer is no.

There are a few reasons why it's different this time.

Firstly, the rates action is happening in the relative boondocks of the housing market, away from the most competitive parts.

ANZ kicked off the latest long term fixed mortgage rate cuts less than a month after the Reserve Bank ended a year long freeze on interest rates by increasing the Official Cash Rate.

ANZ slashed its 5 year year mortgage rate by 75 basis points to 7.75% and cut its 2 year mortgage rate to 7%. See all bank mortgage rates here.

All the other major banks soon followed, even Kiwibank, which has been pulling its lending horns in lately because of a shortage of fresh capital and hot competition for term deposit funding from the major banks.

Back in 2004 and 2006 these cuts would have been big news.

Everyone was borrowing for periods of two years and longer to avoid being stung as the Reserve Bank tried to jack up short term rates to slow down the housing market and the economy generally. It was clearly cheaper for home buyers to borrow for fixed rates then because the headline rates were lower than for variable rates.

That's not the case anymore, which makes the choice much more complicated. Variable rates are typically around 5.9% now, which means anyone taking out a 5 year mortgage at 7.75% is making a pretty big bet that variable mortgage rates will be well above their current levels for most of the next five years.

A home buyer choosing such a rate would essentially be betting that they know better than the market and the Reserve Bank about the future of short term interest rates. That's because the longer term mortgage rates are based on longer term wholesale mortgage rates and a collection of funding costs essentially imposed on the banks by financial markets generally and regulators specifically. The big difference this time around is that banks are finding it much harder to get hold of the cheap, easy funding from 'hot' wholesale money markets overseas.

Before the Lehman Brothers collapse in September 2008 banks were able to get extremely cheap funding that they passed on in the form of fixed mortgages that were cheaper than variable rates. Now the funding costs for these longer term mortgages are around 150-200 basis points higher than they were, which not so surprisingly is the gap now between variable rates and 5 year mortgage rates.

The question for borrowers is whether they can be sure enough about the likely rise in the Official Cash Rate over the next few years to bet they'll be better off with the birds in the bush of a fixed rate than the one bird of lower interest rates now that they have in their hands.

Most are voting with their feet and sticking with the cheaper floating rates, which means these long term rate cuts are unlikely to provide the same boost to the housing market they did in 2004 and 2006. A poll on interest.co.nz this week found 66% would opt for the floating rate, while only 11% would opt for the just-reduced 5 year rate.

That reluctance to borrow long is flowing through into mortgage approval figures, which hit a record low this week. Attempts by the banks to reignite demand with price cuts are yet to work.