Mortgage rates are coming down, say ASB economists, making it risky to fix an interest rate for too long.

In its Home Loan Rate Report, the bank lays out the pros and cons of taking out mortgages for varying terms.

"Mortgage rates have been declining ever since it became clear that the RBNZ would move to cut the Official Cash Rate (OCR) as the economy weakened noticeably," said bank chief economist Nick Tuffley.

Fixed mortgage rates were the first to fall as wholesale rates progressively priced in the expectation of earlier and greater interest rate cuts from the Reserve Bank.

With the OCR itself now falling, floating mortgage rates have started to follow, he said. He expected the OCR to continue to decline to 5.5 per cent in the early parts of next year.

Mortgage rates will keep coming down as the OCR falls, but the financial markets have already factored in these continuing falls, so any drop in longer-term fixed rates was now "likely to be more muted".

"Short-term fixed rates and floating rates will tend to be the main movers."
But, on top of all this is "a large fly in the ointment", said Tuffley - namely the state of global credit markets which became "increasingly gummed up" over the past two months.

"For borrowers, a strategy at present would be to fix for only a short time to tide you over until mortgage rates fall further and offer a broader range of (lower) fixed-term options," said Tuffley.

"This strategy is not without risk given the current global uncertainties. If you place a high weight on certainty, a 1-year rate would give more peace of mind in the short term."

We expect the OCR will drop to 5.5 per cent by early 2009, with scope for more aggressive cuts if needed to counter the impact of global turmoil.

"Assuming some degree of order returns globally, we expect to see floating and short-term fixed mortgage rates to decline over the next 6 months. However, there is no guarantee that the long-term fixed rates will fall, and even if they do they are likely to remain at above average levels.

Our view is that the overall tug of war will be won by the RBNZ, but the impact will be felt mainly on the shorter term rates."

For prospective borrowers, fixing mortgages for short terms - possibly even going to a floating rate - would allow them to benefit from the falling rates.

But this strategy has its risks, says the ASB team. "If certainty is important, fixing for longer than 6 months may be a better compromise between cost and security."