In a fix over mortgage? Think about this
In this chapter from his new book BBQ Economics, Liam Dann delves into the big topic for many homeowners — the household mortgage
What’s going to happen to interest rates? That’s the big one when it comes to BBQ questions. It seems a simple enough thing to ask. It’s almost always because people have a fixed-term mortgage that’s about to roll over and they have to choose a new term.
But actually, it’s a question that takes us deep into the cold heart of the financial system. It’s a leap into a world of investment that we seem to find far more comfortable than that of shares and bonds and other financial products. I guess we feel that houses are solid and tangible; we can kick the walls and inspect the guttering.
It feels like a market that might also be a bit more stable and grounded, sheltered from the arcane vagaries of global finance. I suspect we’re kidding ourselves. Anyway, let’s take a more in-depth look at the costs of borrowing.
How long should I fix?
It’s a weird quirk of New Zealand life that homeowners — and that’s a lot of us — like to take a punt on short-term interest rates, effectively betting on the markets as if we were hedge funds. In fact, Reserve Bank data shows that more than 85 per cent of Kiwis choose to fix their mortgage rates for a set period at a set price, rather than just float along with the market rate. Around the world, habits vary. In the United States, people mostly fix their mortgages for much longer (30-year terms are quite normal) and then they forget about it.
In Australia, only 20–30 per cent of people fix at all; they mostly go with the ups and downs of the market. So, the typical Aussie BBQ question might be: Should I fix or float?
This side of the Tasman it’s almost always: How long should I fix for? In New Zealand, most of us take new short or long positions every year.
Or every two years, or six months, or five years, depending on how we think the market might go. We seem to spend a lot of time worrying about it. But we also seem to love it, because we keep doing it — even though, as a financial strategy, it doesn’t really work. Just take a look at the profits the Australian banks (that lend us the money) are making. In 2022 they made about $7 billion in New Zealand, according to KPMG.
So, who’s really winning? Like gamblers, we convince ourselves that we can beat the bank and somehow get a bargain on our interest rate if we can just make a clever enough decision, and if the market moves in the direction we hope it does. Let me just throw it out there now: This is complete nonsense.
Nothing I can tell you at a BBQ is going to help you beat the banks. Perhaps, if you do it professionally and train yourself by placing bets all day/every day, you might get good enough to win more than you lose. But the odds are you’re a regular homeowner like me and three million or so other Kiwis, and you’re just rolling the dice once a year or so.
I know I sound cynical. I’m certainly not opposed to making an informed choice about what to expect when it comes to borrowing costs. I hope you’ll read the business pages of the Herald and the blogs and websites and use them as a guide. But I’m highly sceptical of the notion — often sold to us by the personal finance industry — that there’s some magic formula which can help you crack the system and pay lower rates than everybody else. There really isn’t. Over the years, I’ve had the privilege of many long conversations with central bankers who are about as knowledgeable as it gets, and the first thing they’ll tell you is that they can’t predict the future. Central bankers have to make very big judgment calls about where to set rates to make sure the economy is stable. If we extend the gambling analogy, they are like the high rollers, the elite who are really good at what they do. And even they can’t always get it right. The problem is that they have to deal with the financial markets like everyone else. And the market is always right — even if it shouldn’t be. The markets that central banks have to bet against are global debt markets. These are usually called bond markets.
Plenty of countries have had their economies tanked by international debt markets at various times. They include Argentina, Greece and Venezuela, as well as 1920s Germany and even the US when the GFC hit in 2008. Mostly, though, in compliant and careful little countries like New Zealand, they don’t move against us. We try to stay within boundaries that don’t cause any major ructions on markets.
Placing a bet . . . or forging a strategy
Anyway, let’s now come back to you: Making your mortgage rate call, throwing your handful of chips on the table for an annual or biennial spin of the roulette wheel. As you ponder whether to fix for one year or two, think about the advice I could give you around the BBQ. Compare it to all the data that is being pored over every day by teams of economists for the major banks. Then think about how all the economic analysis being produced by bank economists is being processed and actioned by steel-hearted traders. These are people who have no fears about moving hundreds of millions of dollars around in seconds, based on a combination of knowledge and old-fashioned intuition. Good luck. Just as it should be at a casino, it’s obvious that, on aggregate, we’re not beating the retail banks or the money markets. That doesn’t mean you can’t get lucky. But most of us only really nail it with spot-on fixed rate picks a few times across the length of a mortgage.
There’ll be a few times where we get it wrong and kick ourselves and call it a learning experience, and then there’ll be plenty more where it’s kind of hard to say how we did. On the plus side, if you have savings and investments, even a KiwiSaver retirement fund, then you’ll be collecting some of those winnings by way of interest or dividends.
Economic knowledge might not help you beat the market, but it will help you contextualise your decisionmaking. You could pick a sensible position that reflects a broad view about the direction the economy is going. Or you could also choose a higher-risk position — with more potential upside. When people ask me what’s going to happen with interest rates, what I really want to say is that they will go up and down and banks will keep making money. That’s the real answer to the most popular question in New Zealand economics.
It’s a bit of a cop-out, though, and it’s too negative. And I want to get invited back to more BBQs. So, let’s run through it again in a less cynical way and ponder the best interest rate strategy for you. Obviously, what you don’t want to do when you set your mortgage rate is exactly the wrong thing. That could cost you a lot of money. At best, you’d feel bad about yourself. At worst, you’d find yourself struggling to make mortgage payments.
Actually, if we’re talking the worst-worst, the bank might force you to sell your home. (For a more positive take, this seems like a pretty grim start.) Unless something really weird happens, like a war or a pandemic (imagine that!), economists have a general idea about the direction the world is travelling and the parameters for interest rates in the near future. So, some knowledge about what’s going on in the economy can help you avoid bad choices. As I mentioned earlier, we Kiwis have a cultural pride thing about trying to pick our own rate — like mowing our own lawns or building our own deck. It’s considered normal. And another thing you really don’t want to be is a weirdo, right? Because the market is so geared towards people choosing short- and medium-term fixed rates, that’s where the best deals tend to end up in this country. It’s the biggest part of the market, so it’s where the most competition between banks happens, which means it’s where there is the most price pressure. And yeah, trying to pick the interest rate market might be masochistic and delusional, but it can also be kind of fun. If you are spending a lot of time in your head worrying about whether to fix for 18 months or two years, at least you aren’t worrying about your health, or your kids, or your marriage . . . or death . . . or whatever.
So, you’re going to get in there and play the game. Even though you can’t beat them, you’re going to join them. That’s fine.
So, what do you need to know? First, let’s nail the real purpose of fixing a price. What we’re trying to do with fixing and then refixing at regular intervals is balance security with flexibility. Rather than look at fixing a mortgage rate as a way to save money, think of it as a way to avoid stress and potential financial ruin. Think of it as a kind of insurance. That’s why big companies fix their borrowing costs or energy prices and even their international currency needs. Companies want predictable prices so they can keep expenditure stable and focus on growing and earning more revenue and reinvesting in the business, and so on.
In theory, we should expect to pay for the privilege of financial security, as we would for any other service. Someone else is taking the risk and we are locking in certainty. But when we stare at the myriad mortgage rates offered by retail banks, we still face a difficult and personal economic choice.
We have to make a decision about where we want to set the balance between flexibility and security — because it’s a trade-off, like so much in economics.
Naturally, it’s important to put your personal circumstances front and centre of any choices you make about locking in your mortgage rate. And to give you useful financial advice, I’d need to know more about you so I could factor in things that are important to your lifestyle — such as your age, for starters. How much security do you have around your cashflow? What’s your income and is it secure? Are you in a small business where work and income can fluctuate wildly from one year to the next? Or are you in a corporate job where the salary is good, but you could be erased in a brutal HR cull in the next business downturn? Perhaps you’re a teacher or a nurse where the salary isn’t so huge, but your employment prospects are steady and secure for life.
All these things should affect the way you set your mortgage to some extent. That’s why professional financial advice is a serious business done face to face by people with certificates on the wall.
What do I do?
If you publish anything that answers questions about your personal approach to finance, you have to include a disclaimer warning people not to construe what you’re saying as financial advice. It all seems a bit artificial, sometimes, like the obligatory encores at rock concerts. But for this next bit, I really mean it. This isn’t meant to be a formula to follow; think of it more as a case study from which you could create your own formula. Anyway, for the record, this is what makes me feel most comfortable. When my mortgage term is up and I have to refix, I take the best available rate at the more short-term end of the market. That’s what most of us do when we buy anything else in our lives: We take the best price on offer.
There have been times when floating rates were lower, but not many since the 1990s. By staying on six-month or one-year terms, I still ride the ups and downs of the interest rate market. It also provides a bit of stability. I do think about things like the market consensus on where rates are headed, but only as far out as six months or a year. After that, neither the economists nor the markets have a good track record of picking what will happen.
Events are too unpredictable. By all means go for terms of two, three or five years if what you want is certainty. But I reckon by the time you get to the preferred Kiwi fixed rate of two years, you’re into territory where the forecasts are becoming a roll of the dice.
We should acknowledge we all have a personal bias forged in the economic events we’ve lived through. For me, it was getting burned a couple of times (between the GFC and the pandemic) fixing for longer terms at higher rates than I needed to, because everybody in the market said rates were about to rise. Through the decade after the GFC, we had several false starts with expectations of interest rate rises. People assumed we’d see a more rapid return to more “normal” elevated rates after the emergency lows of the GFC.
One of the other mistakes people make is thinking there is some kind of normal for interest rates. They really are just what they are and reflect the kind of history we are living through. If rates are high, then it is bad news for us as borrowers. But higher rates also likely mean higher inflation, which means the price of everything is rising fast — hopefully including your wages. If rates and inflation are high, the real value of your debt should be shrinking — which is good news for you and bad news for the bank. There are swings and roundabouts, and across the lifetime of a mortgage it balances out more than you think.
Which is probably why Americans and Brits don’t bother with all the palaver.
What’s crucial is to keep making your mortgage payments. You need to be sure, if you fix a short-term or floating rate, that you won’t be caught out if it rises fast. Fixing longer might cost more, but it means you have less to worry about.
In the end, what you really have to decide is this: How much risk are you prepared to take? What is your capacity to deal with uncertainty, and how much will you worry?