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

By Bernard Hickey

The Reserve Bank has hiked the Official Cash Rate for a fourth time in five months, which should force borrowers to revisit the age-old question of whether to fix or float.

The bank is expected to 'pause' now until December at the earliest before putting interest rates up again, but is still expected to lift them by another 1% next year.

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 both international markets and local markets, where deposits are plentiful.

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 6.75% 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.

What the bank economists say

Bank of New Zealand Chief Economist Tony Alexander argued in his July 3 weekly summary that he would look to fix most of a mortgage for three years.

The trend in interest rates is upward but uncertainty remains as huge as ever regarding the speed and the sort of changes which may not may not occur in response to uncertain developments in eastern Europe and the Middle East. I would look to place most of my mortgage at a three year fixed rate.

ASB's Economists wrote in this August 1 Home Loan Rate Report Borrowers wanting some certainty can still lock in reasonable length fixed-terms at rates lower than the floating rate.

More interest rate increases should be expected over the next two years. Borrowers can at present lock in some certainty and pay a lower rate than current floating rates. Floating rates should be fairly steady while the RBNZ remain on hold, but are still set to rise the most out of all the mortgage rates over the next year.

Westpac's economists said in this August 4 weekly commentary that short term fixed rates were cheaper than floating rates.

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. Among the standard fixed rates, we have no clear favourite. Shorter-term fixed rates, such as the six month or one year rate, are currently low but are expected to rise over the coming two years.

Opting for the three or four year rate would require higher payments up front, but would help insulate the borrower if the Reserve Bank does follow through with an extensive OCR hiking cycle. At this stage, it is not clear which option will result in lower average mortgage payments over the life of the loan.

ANZ economists said in their July 23 Property Focus their analysis indicated a two year rate was most attractive.

ANZ’s carded fixed mortgage rates have all changed in the past month. The changes have not been uniform, with rises in 6 month – 3 year rates and reductions in 4 and 5 year rates.

As a consequence, the mortgage curve has “flattened”, making fixing for longer terms more attractive. Nonetheless, we still regard the 2 year rate to be the sweet spot. The floating rate has not changed, and the 6 month rate remains the lowest rate.