Looming OCR hikes reanimate fixed vs floating mortgage debate

The debate among homeowners on whether they should considering keeping their mortgages on a floating rate or fix them at current levels will re-ignite with a higher official cash rate. File photo / NZ Herald

Signals from the Reserve Bank that it may begin hiking the official cash rate this year will undoubtedly spark a debate among homeowners on whether they should considering keeping their mortgages on a floating rate or fix them at current levels.

Yesterday, the Reserve Bank delivered a delivered a more upbeat view on the local economy, prompting markets to speculate the bank could start raising rates as soon as December, and continue upwards from there.

Based on the MPS projections, the 90-day bank bill rate could reach 4.6% by the end of 2012 from 2.66% now. On that basis, the OCR would rise 2 percentage points to 4.5% over the next 18 months, from a record-low 2.5%.

In retail terms, that would mean floating home mortgage rates would get to about 7.6% next year from 5.6% currently. Longer-term fixed rate home loans may not rise as much, economists say. A two-year fixed mortgage could be had for 6.5% annually this week.

"What we're watching out for particularly is the situation where those fixed rates start looking more attractive to floating rates and a large-scale shift occurs," said Christian Hawkesby, head of fixed interest at Harbour Asset Management.

The decision to switch poses a dilemma for homeowners.

Those who immediately switch to fixed are betting the Reserve Bank will keep steadily hiking interest rates, making the upfront costs of locking in rates worthwhile in the long run.

Those who wait for the OCR to start rising before fixing, or remain on a floating rate are betting that cash in hand savings are worth more than theoretical gains down the track.

"It all boils down to a judgement on how fast floating rates are going to rise," Hawkesby said.

The kiwi dollar rose to a post-float high of 83 U.S. cents today amid speculation Reserve Bank Governor Alan Bollard will start hiking the official cash rate before year-end after he gave an upbeat account of the next few years for New Zealand's economy.

Chris Tennent-Brown, economist at ASB Institutional, said upfront cost is a major factor in the decision to switch out of a variable home loan.

"People looking to lock in term rates are paying a significant price for certainty," Tennent-Brown said. "Even with some rate hikes on the horizon I still think a lot of people will stick with 'cheapest is best'."

According to the Reserve Bank, about 52% of all homeowners are currently floating rates.

Hawkesby said the key factor to watch would be whether floating rates and fixed rates moved in tandem, making the decision a far tougher one.

"Last year some banks were caught out by this dynamic, so they are watching this situation more closely this time around."

After yesterday's announcement from the Reserve Bank, short-term wholesale rates rose by as much as 15 basis points, while longer rates were little changed.