Mortgages are moving on up. The rock-bottom rates, which offered a sweetener for those buying in the boiling market of late 2020-2021, have departed. And investors with mortgages will soon start to feel the pinch.

According to CoreLogic data, around 50 per cent of mortgages will be up for refinancing in the next 12 months. With rates now at the 6 per cent-plus range for two-year fixed, repayments will be significantly higher.

This, coupled with the removal of interest deductibility and the ongoing costs around Healthy Homes compliance, will see investor expenditure head steadily upwards.

But it’s not all doom and gloom. Mortgage rates aren’t particularly high in a historic sense; one-year rates are actually below their 2005-2019 averages of 6.14 per cent. However, this is the fastest six-month increase in mortgage rates since at least 2005, and it’s happening at a time when household debt is at record levels relative to income.

“Given that, it’s no wonder the housing market is on a knife-edge,” says Sharon Zollner, ANZ’s chief economist.

The term structure of the mortgage curve remains steeply upward-sloping, making fixing for longer expensive.

Certainty Has Value

Interest rates started rising aggressively this year and now top 6 per cent for three years at the major trading banks; 7 per cent for five years. Rates will go higher because the Reserve Bank of New Zealand (RBNZ) has indicated there will be more official cash rate (OCR) rises, but the size of any further increases will not hit as hard as what we are currently experiencing.

If an investor is coming off a 2.51 per cent fixed rate on a 30-year mortgage, they will now be looking at 6.05 per cent for two years among the major trading banks, or 5.9 per cent for three years and 6.9 per cent for five years. On a two-year rate that’s a massive 50 per cent increase in monthly payments.

All of this has come about as a result of dramatic rises in wholesale (swap) interest rates, off which mortgage rates are priced.

Zollner says swap rates are sensitive to market expectations of future monetary policy. “While there is no mechanical link between what the US Federal Reserve does and what the RBNZ does, local financial markets started to price in the risk of more OCR hikes here in the wake of the US Federal Reserve’s 0.75 per cent hike earlier in June.

“It is looking increasingly like break-even mortgage rates have peaked, or are close to it.

“If that is the case, from a purely financial standpoint it’s questionable whether it is worth paying more to fix for two years or more. Of course, in an uncertain world certainty itself has value, as does the risk reduction achieved by staggering fixed-rate expiry dates. Mortgage rates will have to rise by a lot more than we are forecasting to make fixing for longer the cheapest option in the long run.”

To avoid the huge amount of pain coming, mortgage brokers and economists are urging investors and owner-occupiers to put a strategy in place to deal with the higher interest rates.

Independent economist Tony Alexander says this year’s interest rate shock should be as bad as it gets for mortgaged investors.

He is predicting rates will not rise much higher than they are now, but restraint on household spending from rising rates will not peak until the turn of the year when most borrowers will reset to much higher rates.

Better Rates To Come

He expects the average one-year mortgage interest rate to be 5.75 per cent next year, declining to 5 per cent in 2024, 4.25 per cent in 2025 and 4 per cent in 2026. If his forecasts are correct, and he gives them a 10 per cent chance, Alexander predicts they will deliver average rates for the next two years of 5.55 per cent, three years 5.37 per cent, four years 5.09 per cent and five years 4.87 per cent, which is considerably better than they are now.

‘It is looking increasingly like break-even mortgage rates have peaked’ Sharon Zollner

“Restraint on the housing market from a sharp jump in mortgage rates is already in place – hence the dearth of buyers. There is little extra real estate weakness to come from the RBNZ tightening monetary policy.”

He says the cost of the RBNZ’s excessive stimulus applied to the economy and loss of focus on low inflation is now being borne by the many borrowers who bought houses on the basis of unusually low mortgage rates last year, not realising the whipping back up which would occur.

Alexander says it now risks overshooting on the other side as the RBNZ strives to rebuild its lost credibility. “Then it will whip back the other way. Meaning what?

“Meaning interest rates are likely to start falling earlier than most people are thinking. Hence the incentive for borrowers to grit their teeth and fix short rather than long. It comes down to one’s ability to ride a roller-coaster running on a steep central bank track.”

His concern is that established behaviour of the RBNZ means just as it failed last year, it may also get things wrong for the next couple of years and continue to be a source of instability in the economy.

“For that reason there is a greater need for investors to think about interest rate risk management in terms of protecting themselves against the poor performance of the RBNZ as well as the usual uncertain economic factors.”

A spread of fixed-rate terms may be best and it pays to note banks are competing mainly in the one and two-year areas. Cash-back offers have returned, and medium to long-term rates are high.” Alexander says he wouldn’t touch the higher rates with a bargepole.

Strategy The Key

A mortgage strategy is more important now than ever, says adviceHQ founder David Green. “The lending environment has changed and what may have been a good mortgage structure a year or two ago is not now.”

He says investors should be proactive in reappraising their portfolio as if it was new to get ahead of a refixing curve. “Many investors are highly leveraged and refixing at higher interest rates combined with the wiping out over the next four years of mortgage interest deductibility is going to hit them hard.”

Green says one of his clients with a five-property portfolio has been looking at how long he can afford to keep all his rentals with huge cost increases looming. He is not alone.

He is looking at whether he can hold on until possibly a National-led Government is elected next year and it ditches the new rules around property taxation. Anyone who has an accountant or registered tax agent won’t be burdened with the new property tax regime until next year.

“Another option is selling one property, but which one is the best to sell because he won’t be able to get any more finance,” says Green.

“It’s a difficult situation for investors as the impact on their cash flow is going to be harsh. They should be reviewing their borrowing strategy well before they have to refix their mortgages. The review should include their personal situation, debt position and risk appetite. Some highly-leveraged investors are comfortable with their position, but for others facing the pain of refixing at more than 5 per cent and they can’t sleep; it is time to look at a different strategy.”

In the non-bank sector, players such as Resimac are offering investor-specific packages to help ease the pain of higher rates. “We can’t change the back-row environment,” says general manager New Zealand Luke Jackson.

“But we are offering a product which is interest-only for 20 years for investors with at least 50 per cent LVR. This is designed to offer surety as they adjust to the cashflow environment.”

In a podcast comment, Squirrel founder and executive director John Bolton agreed with Alexander that interest rates won’t rise much further as they are at a neutral level.

Stability Predicted

“There is a strong correlation between interest rates and house prices. House prices are a function of affordability which is a function of interest rates. Are we going to see interest rates back at 2 per cent? Probably not any time soon.”

Most economists are picking a 10-15 per cent drop in house prices from their peak in November, which should not surprise anyone. Bolton says the country is going to go into a recession, the economy’s going to come off quite hard and fast, and longer term swap rates will come back a bit.

“The OCR’s going to go up but it’s already fully priced into mortgage rates, which should start to stabilise quite quickly.

“Panic runs through the market and everyone’s like ‘[mortgage] rates could get to 8 per cent or 9 per cent’. Clearly no-one could afford that. So, I think the panic will start to dissipate when people see interest rates are stabilising and they’re not nearly moving as quickly as they have been.”

Bolton says people will realise they have to plan a future where mortgage rates are going to be hovering around 5 to 6 per cent. Most people can adjust to that and will get used to it.

He says that there is a little mortgage distress as Kiwis spend 40-45 per cent of their income on housing, but believes people just need to adjust their living expenses. “Every generation goes through this.”

Tips For Paying Higher Rates

With more interest rate hikes predicted, it’s important to have a financial plan in place to help you cope with higher mortgage repayments. Below are some ways to deal with higher interest rates:

• Pay a bit more than the minimum repayment Paying a bit extra pays it off staggeringly fast.
• Start building up a savings buffer now to help you manage higher repayments in the year ahead.
• Take a close look at your budget to identify expenses you can cut out or ways in which you can boost your income.
• Check you're getting the best deal for utilities (power, internet and phone) and pay down any high-interest debt as soon as you can to help free up extra cash to divert into your home loan.
• Use an offset or revolving credit mortgage because this way spare money in other accounts is working to pay the mortgage off. But be warned, you have to be disciplined about applying the money to the mortgage.
• Renegotiate your interest rate. On a half a million dollar mortgage if you can get .2 per cent cheaper it will save $1000 a year, knocking maybe a year and a half off the term.
• Look at other ways to get money from your rental/s: buying a home and income property; building a second house on an existing property if this is financially viable; renting rooms individually; adding an extra bedroom or converting downstairs of an existing property to a second rental.