If your mortgage is due to come off fixed, you’re probably looking at a new interest rate that’s more than double what you’ve been paying. Scary moment. Why has this happened?
In this article we look at some of the main influences on mortgage interest rates in New Zealand. We also use the Covid-19 period as an example of these influences in action. Then we finish with some suggestions for how to keep up with the latest interest rates as they continue to change over time.
Why do mortgage interest rates change?
All lenders, including banks, are a business and need to make a profit. They do this by borrowing money from three main sources and lending it to you at a slightly higher interest rate than they pay to borrow it. Their main sources of money are:
- Customer deposits in things like savings accounts and term investments
- Overseas wholesale money lenders
- The Reserve Bank of New Zealand
Most governments control their country’s economy by changing the interest rates they charge lending organisations like banks. When the economy slows, they decrease their interest rates, so the banks can do the same across all types of lending. This encourages people and businesses to spend more, which stimulates the economy. But it can also lead to inflation. If the inflation rate needs to be reduced, the government can increase their interest rates again, so the banks will do the same. This discourages spending, which slows consumer demand and price inflation.
When New Zealand banks need money, but can’t get it in time from other sources, they can borrow from The Reserve Bank. The Reserve Bank reviews and sets an Official Cash Rate (OCR) at regular intervals to help control the economy. Banks pay the Reserve Bank a slightly higher rate than the OCR, and then they charge customers a slightly higher rate again. So the OCR is one of the things that influences mortgage interest rates, particularly the floating rates.
Changes in overseas interest rates can affect what offshore wholesale lenders charge New Zealand banks. This tends to have more of an influence on our fixed interest rates, as the money is often borrowed at a fixed rate for an agreed term. Longer term interest rates tend to be higher than short term rates because they provide borrowers with more certainty.
What happened with interest rates from 2020 to 2022?
It’s normal for mortgage rates to fluctuate a bit, but the changes over this period were quicker than usual. When the Covid-19 pandemic began, governments around the world rapidly lowered interest rates. They did this to ease the financial burden faced by businesses and home owners struggling to service loans and mortgages. As a result New Zealand mortgage interest rates reached record low levels of around 2%. It was also done to prevent economies from stalling. Lower interest rates meant many people felt confident to spend, so more businesses kept going and more people kept their jobs.
The low rates made servicing a mortgage much more affordable, which led many people to decide it was a good time to buy, creating high demand. Demand caused house prices to rise steeply. Annual inflation, which doesn’t include existing home prices, land values or mortgage payments, also rose quickly to around 7%.
To slow this rapid growth, and start getting annual inflation back to the target of between 1 and 3%, the Reserve Bank began increasing the official cash rate. When floating mortgage rates approached 7% and fixed rates were all in the 5s, the housing market turned. House prices fell significantly driven by the higher rates, tighter lending regulations, increased housing supply, low migration and a backlog of Kiwis heading overseas as borders opened. However, general inflation continued to rise, so the Reserve Bank continued to increase interest rates.
What’s going to happen next with rates?
As always, no-one knows for sure. When house prices began to drop this year, inflation and other economic factors meant many commentators were expecting interest rates to continue unchanged well into 2023, and then gradually decline. However, that predicted decline in interest rates depended on inflation dropping back to the target levels of around 2%.
Inflation isn’t slowing down for several reasons: New Zealand’s currency isn’t doing well against the US dollar, which tends to inflate the price of imported goods; there are ongoing supply challenges from Covid-19; and overseas economies are struggling. And of course there’s a war on Ukraine. We are part of the global economy, so our interest rates will always have to respond to what’s happening in the rest of the world.
The best you can do is stay up with the play. To help you keep up with the latest thinking, we publish independent economist Tony Alexander’s two-monthly interest rate reviews and other housing market insights in our latest news section.
Now’s the time for expert assistance
At mortgages.co.nz we believe it’s important to get professional advice when you’re getting a new mortgage, re-fixing or refinancing. The lowest interest rate may not be the best option for you. A good mortgage adviser (broker) will listen carefully to understand your situation, risk appetite and future plans. Then they’ll make some recommendations for you to choose from. There’s usually no charge to use a broker.