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Bernard Hickey from interest.co.nz on personal finance trends, mortgages, homeloan affordability, credit cards and more

Bernard Hickey: Brother-in-law's guide to mortgages

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I have a brother-in-law who calls me up out of the blue sometimes to chew the fat on what to do about his mortgage.

He usually rings up around the time the Reserve Bank makes an announcement on the Official Cash Rate or when he's read something in the paper about 'now being the time to fix'.

Like most borrowers, my brother in law is on a floating mortgage now and is thinking about whether and when to fix, and who has best rate. I quite enjoy these chats because it forces me to think about how to make these decisions and to put it together into an accessible form.

Please don't take this as financial advice. Everyone has different situations and motivations. Many have different views about where interest rates are headed.
Most economists are saying the OCR is likely to rise from 2.5 per cent to between 4.5-6.0 per cent over the next 2-3 years.

These expectations would make fixing for 2 years slightly cheaper than floating.

Economists from BNZ and Westpac both say that now is the time to fix. ANZ National and ASB suggest floating for now.

After the July 28 statement on the OCR by the Reserve Bank, economists said they expected the bank to hike it by around 50 bps on September 15 and then leaving it at 3 per cent until early next year while it assesses the impact and the global developments, before increasing it again next year.

But for what it's worth, here's my view for myself and my Brother in Law. We both have youngish families, tight weekly budgets and regular incomes.

We're both looking for the cheapest deal for the forseeable future, which is about 18 months to 2 years in our cases. We like certainty, but we're not prepared to pay much for it. We want to repay our mortgages as quick as we can.

Stay floating - the short version

So here's what I say my brother in law should do with his $400,000 mortgage with a floating rate of 5.75 per cent:

The short version is I reckon he should stay floating, but should go back to his bank to threaten to leave and get a discount out of the bank.

The banks have been offering floating rates as low as 5.60 per cent through brokers to new borrowers and he should get the same.

I think a combination of slower global growth for years to come and the drive by many households to deleverage will keep the OCR from rising quickly or too high.

Stay floating - the long version

It's worth trying down the floating vs fixing decision into a few parts. Unlike in the past where fixing was obviously cheaper than floating both immediately and over the long term, now it's a bit more complicated.

The first question to ask is: where will the OCR go and when? The floating mortgage rate is linked much more tightly to the OCR than fixed rates. A decision about which is best depends on where you think the will go.

Market expectations are for a rise in the OCR from 2.5 per cent now to around 4.25 per cent by mid 2013 as the economy recovers and the Reserve Bank is forced to remove its stimulus from 2009 and 2010 by putting the OCR back up.

Westpac's Dominick Stephens expects it to rise to 6 per cent by the end of 2013 because he thinks the New Zealand economy will 'decouple' from a slowing global economy and the Christchurch rebuild will boost construction price inflation.

My view is that households in the developed world are heavily indebted and are keen to repay debt in the years to come. Influential research from economists Carmen Reinhart and Kenneth Rogoff shows that high debt levels slow growth down as an economy deleverages. America, Europe, Australia and New Zealand all have indebted household sectors and/or governments.

Governments and central banks often choose or are forced to engaged in what is called 'Financial Repression' where they hold interest rates artificially low to ensure the economy doesn't go into a tailspin.

They essentially decide that a little bit of inflation will help the economy dig its way out of debt and that savers will just have to bear the brunt.

You only have to look at what happened in Japan after its property bubble burst in the late 1980s. It has endured 20 years of near recession with near zero per cent interest rates. Every time the central bank moved to put up interest rates the economy slid back into recession, forcing the back to put rates down again.

That's what happened last year in New Zealand. The Reserve Bank put the OCR up from 2.5 per cent to 3 per cent and was forced to put it back down again on March 10, albeit after the shock of the February 22 earthquake.

We have a calculator at interest.co.nz that incorporates the market's expectations of the OCR and allows us to work out whether fixed or floating is cheaper.

The market is expecting the OCR to start rising again from September 15 and get to 4.25 per cent by mid 2013. Given the current 2 year fixed rate of 6.4 per cent and a floating rate of 5.75 per cent now, my brother-in-law would actually be better off fixing to the tune of $1,734 over those 2 years if the OCR rose as the market expects.

In my view the market expects too big a rise.

I think the OCR won't start rising until December and then various global downturns and a slow rebuild in Christchurch will allow the RBNZ to keep the OCR below 4 per cent over the next couple of years. In that situation floating would be cheaper than fixing.

- INTEREST.CO.NZ

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