Unexpected announcements of interest rates lifting by over 30 base points from all mainstream banks surprised many of us last week. Whereas interest rates were predicted to remain low for years to come, now turning on a dime and start rising.

At the time of writing (29th of July 2021), the one-year fixed term rates have lifted from 2.19% to 2.5%. In this video, we'll go into depth on the reason for the interest rates increasing and reveal the tactics on how you can deal with it to minimise the impact.

Are higher interest rates coming?

Video timeline

1. Why the interest rates increase? 01:48

2. What can we do? 05:35

1. Why the interest rates increase?

After last year's pandemic, New Zealand has succeeded in boosting the economy and increasing the willingness of people to spend more. The economy has surged as planned, but what not planned on is the inflation in the recent quarter hit over 3 per cent. It is higher than the ideal figure (close to 2%), and it hits a record high over the past ten years.

One of the Reserve Bank's roles is controlling inflation within around 2% in case you're not familiar with:

When the inflation rate is too high, the economy can suffer. People would prefer spending rather than saving because they want to purchase goods and services cheaper before the prices for everything get more expensive. Especially spending on investments (such as gold and properties) since the value is guaranteed. Secondly, the high inflation makes it challenging for exporters and importers to plan the exchange rates because the exchange rates are related to inflation rates. Lastly, for business owners, they will shift their focus from being productive to repricing everything since the costs change dramatically.

Conversely, if inflation is too low, it will inhibit consumer spending and also harm the economy. Only when inflation is controlled and at reasonable levels (around 2%), the economy may prosper.

Many economists comment that Covid variants are causing inflation to go high. New Zealand economy has recovered so well that the Reserve Bank has suspended printing money. The funding cost for banks are getting expensive, and as a result, all the main banks have started raising their rates by a large extent.

Unless reopening the border to resolve the supply issues (e.g., material and labour), prices for goods and services may be pushed to reduce to the level before the pandemic. Otherwise, it’s almost unlikely for rates to drop again. But the reality is the border may remain closed in the foreseeable future.

In our view, it seems unlikely for the rates to go back to the record low level before. Some economists predict that in two years' time, the official cash rate (which also drives the shorter-term interest rates) will increase by 1.5%. So you probably expect 4% interest rates.

2. What can we do?

To many borrowers who just started a home loan over the last year or two, you probably would think the rate is so unaffordable. Whereas for the long-term borrowers who had experienced the GFC time when the interest rate was at 9%, the current rates are still close to the record low. So it depends on what you're experiencing, but the cost of borrowing has definitely gone up.

Since it appears unlikely for the rates to go back to a lower level, what can we do about it?

Now can be a good time to review your interest rates, even though if your home loan is not coming off fixed term. This is because:

Firstly, from our experience, the break cost at the moment is very low, and, in some cases, it will cost you zero dollar to break the loan. This is because when the rates are in the rising trend, banks are happy to break your loan as there is almost no cost for them. The best way to figure out how much it would cost to break your loan is to contact your bank directly (unfortunately, we cannot calculate that for you), and then we can help you do the analysis and give you our best possible advice in your situation. Since breaking loans may costs you almost nothing, why not review your interest rate strategy while the rates are not too high?

Secondly, there are some other factors that may affect your cashflow. For example, (a) you expect your income to be reduced, (b) your loan coming off from interest-only to principal and interest, which could double your payment, (c) you have to pay more tax on your rental properties due to the interest deductibility rule which was introduced Mar this year. (d) you reach the threshold for high income (over $180k annually) and have to pay more tax from this year. Before the interest rates increase further, it’s best time to review your interest rates strategy.   

So, how long should you fix for?

The two-year rate sits relatively high (range from 2.89% to 2.95%). Although the one-year rate, 2.45% - 2.5%, is still the cheapest, it's not necessarily mean fixing your loan with one year is your best choice. You might be wondering should you go with a two-year rate straight away? or fix it with one year and then roll over for another year?

It's hard to predict the trend of interest rates, so when considering how long to fix, you need to analyse your own situation. If you're conscious about the interest rate and you expect the potentially high rate (4% for example) may cause some pressure in your life, then you can consider locking at least some portion of your loans for a slightly longer term (18 months or two years), rather than fixing all your loans for one year. You can still fix some part of your loan with one year because it is cheaper, but you also hedge for the longer term in case rates do go up by 1.5% in two years' time.

Prosperity Finance - Here to Help

If you would like to get more tailored advice, please feel free to get in touch. We are happy to review your situation and let you know how we can help. Call us at 09 930 8999 for a chat with one of our financial advisors.

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Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.