Mortgage outlook: Variable

There are some truths in our economic landscape that everyone relies on. The Warehouse is usually cheaper than anywhere else. Renovations always take longer and cost more than you budget for. And until recently, a two-year fixed-rate mortgage was always cheaper than a variable rate mortgage.

This norm was one of the underpinning factors that drove the housing boom between 2002 and 2007. Homebuyers could be certain banks would compete hard to offer an attractive two-year mortgage rate. This gave buyers some certainty. If the worst happened, two years was long enough to buy and flick a property before any pain hit.

New Zealand was unusual in this respect. By mid-2007 more than 85 per cent of mortgages in New Zealand were fixed-rate mortgages, but in Australia only 20 per cent were fixed. Even now our fixed-rate proportion is just under 80 per cent, while it has dropped to 6 per cent in Australia. Monetary policymakers lamented our attachment to fixed-rate mortgages because it handicapped the Reserve Bank's ability to move our economy with the Official Cash Rate, which is linked to variable mortgage rates.

The cheaper fixed rates were also a symptom of cheap money being pumped into our housing market. This money was exported from the United States and Japan at extremely low interest rates (0-1 per cent) and sold to us through the "swaps" markets at higher rates, ranging from 5-7 per cent after a mark-up from our banks.

But something has changed. In recent weeks this foundational truth of our mortgage and housing markets has been turned upside down.

Now variable mortgage rates are significantly cheaper than two-year fixed rate mortgages.

A combination of lower variable rates and a steady climb in fixed rates has been responsible for a reversal in the typical mortgage rate curve for at least the past six years. This means the best variable rates are now around 5.8 per cent, while the best two-year rates are around 7 per cent.

Banks are reacting to a couple of forces that may have changed the economic landscape forever. These forces may also change the driving factors in the housing market and in household budgets for the next decade.

First, longer-term interest rates globally are rising because governments are on the biggest borrowing binge in history. The US and British governments are borrowing more than 10 per cent of GDP and will have to continue this for years.

New Zealand is not immune. Finance Minister Bill English has just returned from a tour of capital markets in the Northern Hemisphere, where he promoted the sale of up to $40 billion of New Zealand government bonds over the next five years. This will push up longer-term interest rates.

Second, the Reserve Bank is encouraging banks to fund lending from longer-term and more domestic sources. This means they cannot easily and quickly go to wholesale markets to find cheap "hot" foreign money. They are passing on those costs in the form of higher fixed mortgage rates.

Finally, competition for new mortgage market share is not as intense. In the boom years from 2003 to 2007, the banks used low fixed mortgage rates to grow their market shares. Now some banks have taken their foot off the growth pedal.

ANZ National's growth has slowed markedly as its parent in Australia looks north to Asia for growth, while ASB has also slowed as it tries to reduce reliance on the mortgage market. Only BNZ and Kiwibank are still growing mortgage market share reasonably quickly. Westpac has also hit the go-slow button after a series of high-profile mortgage market losses.

Buyers cannot rely any more on cheap fixed-rate mortgages. That may make them think twice before buying, because disposable income for those with mortgages will become more variable.

Over time it will empower the Reserve Bank to shift the economy around faster.