The great mortgage conundrum

By David McEwen

Monday 22nd April 2002

Brace yourselves! Interest rates are moving up.

Reserve Bank governor Don Brash has raised official interest rates twice in the past month, from 4.75% to 5.25%. This has pushed up floating mortgage rates by a similar amount, from around 6.7% to 7.2%.

Some pundits are forecasting interest rates could keep on rising and mortgage rates may even break through the 9% mark next year.

If they are right, and that cannot be guaranteed as interest rate movements are notoriously difficult to forecast, then it seems like a sensible move to lock in mortgage rates at a fixed interest rate for as long as possible.

Fix your mortgage for two years and you will pay just under 8%. Four years will cost you 8.3% and five years will cost closer to 8.5%.

If floating rates go up to 9% or beyond, then those with fixed rates will be congratulating themselves.

But what if interest rates don't stay up? The local economy might be performing well now and the world economy is gradually recovering. But that could change if deflationary pressures in Asia widen, or the US goes back into recession after a brief period of recovery, as some are predicting.

That could see interest rates coming down again, which would be painful for those who have locked in their rates for many years.

Even if they do go up, what is the impact in dollar terms? Here are a few scenarios and their impact on payments over five years.

Let's say you have a $100,000 mortgage being repaid over 20 years. At the current floating rate of 7.2%, your monthly payment would be $787.43.

If you lock in a fixed rate for five years at 8.45%, you will pay $865 per month. Over five years, that amounts to a total cost of $51,880.

Now let's assume you stay with floating rates instead of fixing and they move up to 8% this year, 8.5% next year and 9% in 2004, where they stay for another two years. Over five years, your payments would total $52,841.

That's an extra cost of $16 per month over the fixed rate. If they were to move as above, but fall again to 8% and 7.5% in the final two years, the costs over five years would be $51,699 or a saving of $3 per month on the fixed rate.

Finally, if they were to rise only a fraction to 7.5% and stay there, the total bill would be $48,335, around $59 per month lower than having a fixed mortgage. These numbers suggest there is only minimal benefit in having a fixed mortgage.

The big gains kick in if interest rates go markedly higher than forecast, say to 11%. That would result in thousands of dollars in savings over five years.

However, there doesn't seem to be any strong likelihood of that happening. Inflation is still firmly under control and Dr Brash will be making sure it stays that way.

These examples would seem to suggest that a fixed rate mortgage has a greater impact on people's personal comfort level than their wallets.

Feel free to fix your mortgage if you like the certainty of paying a set amount every month or fortnight. If not, there's no need to lose sleep if interest rates creep up a little.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz

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