Borrowers faced with difficult mortgage decisions

With interest rates falling and the mortgage market in a state of flux, people are increasingly pondering two questions. Does it make sense to fix home loans in the current environment? And, if so, for how long?

CoreLogic Chief Economist Kelvin Davidson said that while the perfect strategy for fixing mortgage rates could only be known in hindsight, the latest data suggested it might make sense to fix for a short period. Certainly, that's how many borrowers are acting.

 

“As it’s become clear in recent months that the medium-term outlook is for fairly steady declines in the official cash rate (OCR) and mortgage interest rates, there’s been a strong preference for borrowers to take out short-term fixed loans,” he said. 

 

“In December last year, for example, 36% of new loans (by value) were taken out for a fixed term of up to 12 months. But that had spiked to 56% by February and reached a new record high of 68% in August – driven by an especially large surge in six-month activity, off the back of that first OCR cut.”

 

Hindsight suggests it might not have been a good decision for borrowers to fix for short periods in mid-2021, when loans were at record-low levels, as they subsequently rolled off to much higher interest rates, according to Mr Davidson. 

 

“Indeed, anybody who bucked the trend and took out a five-year rate of around 3% at that time will still have about 18 months to run at those ultra-low rates. On the other hand, one can understand why borrowers are now choosing to take shorter fixed periods in the hope they will benefit from a series of loan renewals in the coming year or two at ever-lower rates.”

 

Interest rate outlook remains unclear

 

Mr Davidson said no one could be sure about the right course of action for borrowers right now.

 

“After all, the very short-term rates (e.g. six months fixed at 6.7%) remain quite a bit higher than the slightly longer terms (e.g. 12 months fixed at 6.2%) – so for the strategy of taking two consecutive six-month fixes to pay off (i.e. to get the lowest average rate over the relevant term), that rate basically needs to drop to 5.7% or less by April next year,” he said.

 

Mr Davidson said that could happen if inflation fell more sharply than expected and the OCR therefore fell more rapidly. However, given that some of the potential future falls in the OCR had already been ‘priced in’ to current mortgage rates, the scope for further declines was limited, he added.

 

Furthermore, even though interest rates were now falling, it didn't necessarily mean we'd passed the worst for financial stress among borrowers, according to Mr Davidson.

 

“Indeed, the non-performing loans ratio (loans that are at least 90 days in arrears or regarded as impaired) on banks’ books has recently edged up to around 0.6% of existing mortgages, the highest figure in more than a decade,” he said.

 

Given the state of the market, you might be noticing some uncertainty in your clients. In that case, please refer them to me. I’ll be happy to explain their mortgage options to them and model different scenarios, so they can make an informed decision about what to do.