For anyone that had a mortgage 35 years ago, today’s interest rates must be mind-blowing. Today’s one-year interest rate, which is hovering around the 2.5 percent, is almost one-tenth of the 20-plus percent interest rates that were common in the 1980s. And in the past month, most economists have begun forecasting that a negative official cash rate is possible, even required, in 2021, meaning rates could drop even further.
The first question that inevitably comes to mind for property owners is: is a negative mortgage rate possible?
Believe it or not, there have been examples of negative interest rates in the past. I have heard of mortgages in the UK in the peak of the 2008 financial crisis where monthly payments were, for example, £1000 and the overall mortgage would reduce by £1025. This equates to a negative 0.25 percent interest rate.
At that time, mortgage defaults were so bad that the banks were desperate to simply have some money coming in so a negative interest rate was simply a reward for continued payments. That’s unlikely to happen here.
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But if the OCR drops below zero, mortgage rates will almost certainly drop from their current rates and could easily go below 2 percent. If you have a mortgage rate that is due to mature soon, you need to take this into account when fixing your mortgage. Your two main options are to leave your mortgage on a floating rate and wait for the interest rates to drop further, or fix at today's rate.
My suggestion is that, if you agree the rates could go lower and you want to take advantage of that, you focus on the short-term rates (ie one year). Not only are these the cheapest rates, they will be maturing in the third quarter of next year, which is only a couple of months after economists are forecasting the OCR to drop. Floating rates are typically quite a bit higher than the fixed rates. Leaving your mortgage on floating and waiting for the drop in the OCR means, for the majority of people, paying a premium now on the off-chance that interest rates will drop in the near future.
Recently, some banks have lowered their “servicing rates” - the percentage that the banks calculate your affordability at. Even though interest rates are actually at 2.5 percent, the banks are still calculating if you can afford a mortgage between 5.8 percent and 7 percent.
A negative OCR is going to put the banks between a rock and a hard place. On one hand, a negative OCR is designed to encourage borrowing, not saving, and the Reserve Bank will want people to be purchasing property. On the other hand, banks are bound by “Responsible Lending” requirements and will be very hesitant to lower the servicing rate. They want to know you can afford your mortgage in three to five years time when interest rates could potentially be higher again. It would be surprising for the servicing rate to drop much below 5 percent. In other words, actual mortgage interest rates will be cheap but you will still need good income to successfully get a mortgage approved.
There will come a time when interest rates will go up again and people will regret not taking advantage of the longer-term (three to five years) interest rates. If you want the confidence of knowing what you are going to pay over the next few years, these fixed terms may be right for you now. But if you are willing to take the bet that interest rates will be lower this time next year, as most economists are saying, the one year fixed rate could be the best option for you.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
