To fix or to float? That is the question

Home owners with mortgages may have noticed that over the past month, bank fixed lending rates have come down to the point where out to three years the interest rates are not too much above current floating mortgage rates. For instance, at the BNZ our floating rate is 5.74 per cent (Total Money product) whereas the three-year fixed rate is 6.15 per cent. That gap of just 0.41 per cent compares with a gap of 1.4 per cent in November and is the smallest since March 2009.

Between floating and fixing for two years at 5.79 per cent, the gap is almost nothing – 0.05 per cent. In November this difference was 0.86 per cent and the latest gap is the smallest since May 2009.

So is now the time to fix? To answer that we must consider a few things. First, is it likely that floating interest rates will fall soon? No. Bank floating rate funding costs have risen in recent months because of tightness in European banking markets – to the point that in Australia, banks have just increased their floating mortgage rates without the Reserve Bank of Australia having changed its cash rate. New Zealand economic growth is weak, but acceleration is likely later this year. So the chances that our central bank will feel they need to ease again are low.

Are floating rates likely to jump soon? No. Growth prospects for New Zealand are still fairly muted and risks abound overseas. But floating rises are likely early next year and could easily occur to a small extent before the year is out.

Are fixed interest rates likely to fall further? One cannot rule out some competitive actions by lenders, but internationally, investors are starting to take a glass-half-full view of things. The United States economic data have been reasonable recently, the Australian central bank failed to cut interest rates last week as expected and few analysts now expect any further easing; things are looking less dire in Europe, and there is increasing questioning of the US Federal Reserve’s forecast that it won’t raise its cash rate until 2015.

The chances are that fixed interest rates have bottomed.

Then there is the comment I was making about a year ago with regard to what would drag me away from sitting on floating. I wrote that I would fix if presented with a two-year fixed rate at 6 per cent or a three-year fixed rate at 6.25 per cent. I can now get both.

Therefore, if I were a borrower what would I do at the moment? I would switch from floating into either a two-year or three-year fixed rate.

Personally I like a bit of certainty in my life so I would opt for the three-year rate in expectation of the floating rate rising above it within about one year. At a minimum, however, I would take the two-year rate as I get rate certainty for two years in an environment where floating rates are highly unlikely to fall. It’s a gimme.

But it pays to remember that we have been in this situation before and suddenly things have gone bad in Europe and worries about global growth have sent wholesale interest rates plummeting. Could that happen again? Not to the same degree given that compared with June last year, when this last happened, wholesale interest rates are much lower. So scope for declines is less.

As well, we are three years down the track from the global recession ending and while big problems remain, there are more positive signs than before.

Will we see a repeat of March 2009 when my call to fix helped propel the three-year fixed rate up almost 1 per cent in a fortnight? No, because most people seem happy floating and are not fearful of interest rates jumping up.