David Whitburn

There’s a lot happening with interest rates at present, with many severe interest rate movements.  Also I have heard financial commentators on the radio, read in newspapers and seen on TV about how interest rates are going up, interest rates are going down and interest rates are going to stay relatively stable.  This is causing confusion amongst many borrowers.

The thing is all the commentators may be right.  This is because there is no such as the one interest rate.  For example if you went to your lender to get a loan right now, if approved you would be offered the choice of a floating or fixed rate.  If you choose a fixed rate, you would be offered the chance to fix this for 6 months, 1 year, 2 years, 3 years, 4 years, 5 years and if you are with BNZ, you have the additional choice of a 7 year fixed interest rate for maximum certainty.  For my overseas readers, we sadly do not currently offer the 10, 15, 20, 25 and 30 year fixed interest loan periods that many other developed countries and in particular the USA have.  I am hoping for a 10 year fixed interest rate in the near future – but I got told by a leading banker that this is unlikely.

Current interest rates

Leading financial website Tarawera Publishing Limited lists all interest rates from their providers.  I would highly recommend all serious property investors bookmark their interest rates page:  http://www.mortgagerates.co.nz

The average floating rate across all major banks is a smidge over 6% (when acknowledging the Westpac Choices rate discount).  The fixed rates for when you lock in a certain defined interest rate for a set period of time, have a strong yield curve currently.  That is the rates of interest you pay as the length of time you fix go up sharply.  It has to be noted that this yield curve is now flattening (visually you can see this here).  Floating rates have gone up a bit, and the longer terms rate down a lot lately.

From last Thursday to today all the major banks dropped their 2- 5 year fixed interest rates.  We saw a week or so after the Official Cash Rate was put up 0.25% by the Reserve Bank that the floating rates went up by around 0.25%.  The OCR doesn’t strictly control interest rates.  It however is highly influential on short term (variable, 6 month and 1 year fixed rates).  On longer term fixed rates (3, 4  and 5 year) it is not very influential at all.

These longer term fixed rates are driven more by the returns NZ term deposit savers expect, and thanks to the Reserve Bank’s rules in June 2009, banks are not permitted to raise as much ‘hot money’ that they got from institutional foreign lenders – this was short term money typically rolling over every 90 days.

What Borrowers Should Do?

As mentioned in previous blogs on financial topics, do not have all your borrowings on one rate. Split your borrowings across a variety of interest rate periods.  Just like I advise having different banks as your property portfolio grows (to avoid the one bank trap – thanks Kieran Trass for teaching me this in 2003), it is imperative to split your borrowings at times like this.  Consider having a property schedule like I do and all my mentoring students do, where they have the loans on their properties set out including the fixed period expiry date.  Then graph this to split your borrowing and have an interest rate averaging strategy (“IRAS”) for your borrowings.   Imagine if you have total loans of $600,000.  You split them in this way:

1. $100,000 floating at 6.00%
2. $100,000 1 year fixed at 6.50% fixed interest rate period expiring 5 July 2011
3. $100,000 2 year fixed at 6.90% fixed interest rate period expiring 5 July 2012
4. $100,000 3 year fixed at 7.30% fixed interest rate period expiring 5 July 2013
5. $100,000 4 year fixed at 7.60% fixed interest rate period expiring 5 July 2014
6. $100,000 5 year fixed at 7.80% fixed interest rate period expiring 5 July 2015

In one years time your loan when the one year fixed rolls over, ie loan 2, you fix this loan for 5 years so it expires on 5 July 2016.  That way you have 6 loans all expiring at different times.  This does give you some protection in that if interest rates move up suddenly by 3% in one year (unlikely but possible), you only suffer an average rise of 0.5% in this way (as opposed to suffering all 3% rate increase if you were floating).  Conversely if interest rates fall 3% in one year, you would only get 0.5% saving, than if all your interest rates were floating.  This IRAS also makes choosing your next interest rate period quite easy!

Now of course life isn’t that simple and you can’t expect to be able to do this exactly – I don’t.  In fact like my mentoring students who I professional advise I am overweight to loans expiring around March 2014.  I broke this IRAS when the 5 year interest rates were so fundamentally cheap in March last year – I just couldn’t help myself!  The result of this is the saving of hundreds of thousands of dollars in client wealth from the number of people I was able to convince 6.5% for 5 years was a great deal.  It wasn’t a hard sell either – the catch is you have to follow financial cycles and interest rate movements.

Issues

There is a risk of a double dip recession.  Lets face it, whilst we are out of a recession the market is hardly booming.  I see Mortgagee Sales slightly rising, the number of days to sell a house rising, more fear in the market as to house price drops owing to fears investors will sell up with reduced returns thanks to the ETS, GST rises they cannot pass on (residential rental income is excluded from GST, as are interest costs, but rates, repairs & maintenance, property management fees etc are all subject to the GST increase).

With floating rates rising and scheduled to rise over the next 18 months, their may be some benefit fixing your rates.  The 4 and 5 year rates at around 7.5% – 7.85% now are looking more attractive (they simply weren’t at 8.5% or so).

The 2 and 3 year rates at 6.74% – 7.3% are other good possible options.  No-one has a crystal ball.  I think house prices will continue their slight decline to be down around 5% for the calendar year 2010.  This is on thin volumes too.  There is no doubt that we are in a property market downturn stage of the property cycle.

Talks of a recovery are too swift.  You only need to drive around Albany, down Wairau Road, around the back of Lynnmall in New Lynn, along Marua Road and to talk to commercial property investors and agents, look at the share price and annual financial reports of the listed property trusts to see that the commercial property market is struggling.  Taking depreciation off commercial property owners (including many owner occupiers) as well as residential property investors hasn’t helped things either.

Without trying to sound too special, I did say fix your borrowings last March in my blog titled Why are you floating – FIX LONG NOW!  If you didn’t consider my opinion and thought that you could outsmart the financial markets, and were proved wrong, you may have cost yourself and your families many thousands of dollars in extra interest paid to your bank.  That is ok, everyone makes mistakes including me.  However there is little point trying to fix it by floating everything now.  Spread your risk and spread your borrowing across a variety of interest rates, floating and various fixed terms.

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