Playing the rule of thirds in the NZ home loan game
With mortgage rate increases on the cards of the next few years, home buyers already navigating a gauntlet of high LVR restrictions, record asking prices and the daunting prospect of an OCR hike early next year, find themselves undertaking home loan comparisons with renewed fervor.
The line is no longer gray – the NZ property market belongs to the seller. That’s thanks to the chronic housing shortage plaguing New Zealand’s most populous cities. Price increases in Auckland have sped along at a blistering pace of 12.5%, and whilst the government and RNBZ fumble about in a frantic dance to somehow smother the high rates threatening to ignite and potentially bring the roof on the market crashing down as another housing bubble pops and spills over into the rest of the economy with disastrous consequences, buyers are left with little recourse of their own to afford the home of their dreams – apart from trying to outsmart the mortgage market.
Missed the bus
Many floating rate mortgage holders and investors alike have found themselves standing shoulder to shoulder on the side of the road as long term rate hikes by all the major banks have left them in the dust of lost opportunity. With increases looking to reach around the 7.5% mark by 2015, those currently considering taking out a floating rate for a year or two might feel that they will gain immediate short term relief, but come time to refinance they will be left with nowhere to run, forced into a corner where the only way out will be to sign up to a significantly higher rate.
Step by step into disaster?
Another pitfall buyers should avoid is to attempt a step by step, or year by year, fixed approach to playing the mortgage rate game. As it stands, one year rates are below two year rates which in their turn are below five year rates. Whilst a lower yearly rate of around 5.5% may look to be the most affordable option, it can in fact turn out to be nothing more than a gradual and costly descent into the realm of punishing repayments a few years down the line.
This is because, with all predictions pointing at a sure and steady rise of both the fixed and floating mortgage rate, when it comes time to refinance at the end of each year the home owner will be forced to take on a higher rate at each and every transition. It would be better to lock in at a five year fixed rate of 7% than cautiously shuffling from one fixed year mortgage to another – but even that move is not without considerable risk and unnecessarily constrains you to being a slave to your monthly repayments with no recourse to making higher repayments should the rate drop or your cash flow situation change.
The rule of thirds
Placing all ones nest eggs in either basket – fixed or floating – is something all the experts are now cautioning against. The buzzword on the home loan circuit is diversification. Spreading out the risk as well as the opportunity to cash in on unexpected turns of good fortune – a sudden pay raise, an unexpected inheritance, the maturation of a savvy investment option or the unexpected downturn of the mortgage rate in the future – is being touted by those in the know as the mortgage rate move for smart buyers to make.
Diversifying your mortgage into three different kinds is all about generating some financial flexibility for yourself as well as redistributing your risk should rates surge higher than expected. By allocating one third of your home loan to a floating rate, one third to a fixed rate of between one and two years and the final third fixed for 5 years, you will be giving yourself some much needed flexibility in your mortgage options to better insulate you against risk in the future.
Bend, don’t break the bank
Applying the rule of thirds to your mortgage strategy will ensure that should the prevailing winds switch to either a higher or lower rate, you will retain the flexibility to buffer yourself against the blows (in the case of rate hikes) or to capitalize on downfalls should the rate drop or your income increase to allow you to make larger repayments without incurring the penalties associated with fixed rate schemes.
So, for those looking to weather the storm of rising NZ mortgage rates which has now begun to track it’s path across the housing market, the best strategy appears to be to split the risk and diversify.