Issue 51 - Interest Rates – the continuing story - May 2009

Interest rates for those with or wanting a home loan are on the rise again.
Given the critical shortage of funds, this is hardly surprising.

In recent months, even large businesses have been hard-pressed to find sufficient funds from the trading banks to simply maintain their levels of borrowing, let alone obtain extra funds for any expansion plans that they may have.

As a result, many have gone directly to the retail investors offering very attractive rates and terms for bonds. With interest rates ranging up to 8%, these issues have been very quickly filled by those who only recently viewed with dismay the plunging returns on their bank deposits.

In consequence of this, the banks have had to increase, to some extent, the return that they were offering on deposits with them which has, in turn, increased their cost of borrowing within New Zealand.

Further to this, ANZ National recently borrowed $1.0 billion (U.S.), using the N.Z. Government’s guarantee scheme to enable it to secure the funding. The interest rate mentioned in respect of the borrowing, it is reported as being ‘very costly’ and above the rate at which funds are being on-lent to home owners. On top of that, of course, the bank has to pay the Government a fee for issuing the guarantee. (Until the N.Z. scheme’s charges came more into line with Australia’s, no-one had availed themselves of the facility. Now that charges are closer, the guarantee is beginning to work the way it was intended.)

So – what should aspiring home-owners do?

Should they wait for interest rates to come down again or should they buy now?

I think that the most important things to think about are the reasons for buying a home in the first place. Reasons such as security of tenure, pride of ownership, ownership of an asset that over time, will grow. Most of all, peace of mind in the years ahead when you will be living there mortgage free.

As to the interest rates, I would tend to think of it like this:

The most likely result of someone buying a home will be having a home loan for, say, twenty-five years. During the term of the loan, it is likely that a whole range of interest rates is going to be encountered. If it is a floating rate it will, naturally, rise and fall with the interest tide; if it is fixed, it will be so only until the next review, at which stage it may move up or down.

Given the above, what matter if, when buying a home, the prevailing interest rate is a little more than you would like? On a $300,000 loan, the maximum  amount of extra interest that would be payable over one year, with a 0.25% increase in interest, would be $750.00 – about $2.00 a day.

Ideally, borrowings should never be made on the basis of borrowers having to strain their finances to the utmost, to be able to pay the fortnightly or monthly loan repayments. What may be tolerable for a short time can very rapidly become intolerable if there is no cash left over for a little fun. Far better to wait until a bigger deposit has been saved, than over-burden yourself with high debt repayments.
 
Of course one of the things that many home-buyers do is buy a home that is far too big for their current needs – or even their foreseeable future needs. I suspect that this is sometimes to impress friends and family rather than to provide for the accommodation needs of the immediate family. This is a little like leasing an expensive car just because it is known to be expensive – it impresses.

Too expensive a house or too expensive a car will impress – but at what cost? Would you rather appear not well off, but lead a comfortable life or appear to be rich, but spend all your time scratching and scraping along because of high debt levels? I know where I would rather be!

It seems to me, therefore, that the best way to go now, for a lot of aspiring home-buyers, is to buy now if you can. With the volumes of ex-patriots returning to New Zealand, my feeling is that the present prices may not last for more than a few months. When you are buying, however, buy something that you can afford now and at least get a foot on the property ladder. So, the suburb may not be your ideal, the property may not have all the features that you would like – but it will become a home to you. Later, when you have more disposable income, will be the time to go for that better suburb, the bigger home.

Finally, it would be a good idea to structure your home loan so that you have (for example) part of it on a fixed (longer) term, part fixed on a shorter term and some on a floating rate. The advantage with this arrangement is that you place in the ‘floating rate’ portion, that part of the loan that you may wish to repay earlier, but at your discretion, should you have some funds left after paying all your current outgoings.