Boom and bust

by The Listener / 28 February, 2013
Borrowers tempted by low interest rates should remember higher rates are always around the corner.
Boom and bust
Photo Getty Images/Listener photo illustration

Never say never. When the sun is shining, it’s hard to imagine rain. Similarly, when our personal finances are in good shape, it’s difficult to anticipate them turning to custard.

So, Kiwibank‘s new low six-month mortgage rate of 4.79% makes it hard to imagine interest rates rising to around 8.6% by the end of 2015, or less than three years away.

Mortgage rates are unusually low at the moment, something first-time or highly indebted homeowners need to remember. Those longer in the tooth recall rates of 20%-plus.

It’s tempting to borrow as much as you can to buy a more upmarket house on the basis that the property will never be cheaper. But it’s dangerous to think the good times will continue forever.

Infometrics economist Gareth Kiernan, who is forecasting a big jump in interest rates during 2014 and 2015, admits he’s at the upper end of what many of his peers are predicting, although Westpac Bank is making similar noises. Kiernan thinks the Reserve Bank official cash rate (on which mortgage and other rates are set) could rise to about 5.5% – up from 2.5% now. Ouch!

Of course, many say the Reserve Bank shouldn’t use interest rates to control inflation because of the effect that can have on the level of the dollar and other parts of the economy.

For example, imposing interest rate rises to stop a full-scale boom (and bust) in an overheated Auckland property market doesn’t seem fair to house buyers in Palmerston North or Timaru, where prices are pretty stable. In any case, controlling inflation didn’t halt the property boom midway through last decade.

The alternative is to try to find other ways that won’t further push up an already buoyant exchange rate. So, the Reserve Bank is looking at what else it can put into its tool kit to stop regional property booms.

There are many technical options. The one most talked about is for banks to require borrowers to have bigger deposits. This means instead of a bank lending nearly 100% of a property’s value, the most you could borrow might be limited to 85%.

But that seems to unfairly penalise first-home buyers trying to scrape together enough equity. It also whacks all purchasers, regardless of whether they are trying to buy in Ponsonby, Petone or Putaruru.

Another tool is to impose capital ratios on banks. For example, banks could be required to be more cautious lending to someone buying in a booming (therefore potentially riskier) region than to a borrower in a stable area.

Other tricks of the trade include making banks fund their credit growth from long-term and more stable sources or requiring more conservative accounting standards.

The Reserve Bank is considering a variety of options and I hope, if it goes for more sophisticated controls than just official cash rate adjustments, it looks carefully at the whole range.

There’s always a danger – under pressure from voters – that governments will act precipitately to try to limit something unpleasant. There can be unintended consequences. The trouble is economic equilibrium is unachievable. Every time some major event happens, or a control is imposed, there’s a counter-effect.

For example, the Auckland housing bubble is at least in part caused by a lack of new housing. That, in turn, resulted from the 2008 financial crisis, which left property developers without funding. And so it goes on …

As a borrower, you should work out what the interest bill would be should rates rise. On a $300,000 20-year mortgage at 4.8%, you’ll pay $1947 a month; at 8.6%, monthly repayments would be $2622, or $675 more. In a worst-case scenario, could you find that extra money every month?

In the meantime, you should investigate fixed-rate options to lock in current low levels.

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