How to navigate the world of falling interest rates…

We all know the story, since 6 October 2021, we’ve had relentless OCR increases all the way up until 24 May 2023 when RBNZ put a pause on further increases and left the OCR at 5.5% for >1yr to address what seemed like a never-ending war on inflation reaching a peak CPI of 7.3% in June 2022 – the worst inflation in NZ for >30yrs.

Fast forward to 14 August 2024 and suddenly, the certainty of the OCR being on hold at 5.5% (or increasing) was in question for the first time in forever and some even picked a rate decrease (heaven forbid).

Inflation in June 2024 had reached a much more comfortable 3.3% and with CPI inflation improvements (along with a need to balance “employment prospects” in recession) came the uncertainty of the next OCR update as “just another OCR update being on hold” or will there even be a decreased OCR?

RBNZ decreased the OCR to 5.25%, wholesale rates followed and have been steadily decreasing whilst within a month the banks dropped interest rates across all categories. For example, the 1yr rate went from being 6.85% to 6.19% and the norm for any fixed term >1yr to be <6%.

The below 1yr swap rate graph illustrates our current falling rate environment following largely the same CPI/wholesale regression as the last major rate decreasing environment (the GFC) – with a few bumps along the way:

So where exactly does that leave clientele who have fixed for longer?

Well, sort’ve a rigged game as the bank locks in your lending with their providers, and any attempt to exit earlier than committed, will attract a break cost - not to be confused with a bank fee, it’s an actual cost to the bank as it costs the bank money to exit and redeploy those funds at cheaper rates.

For example, let’s say you fixed for 2yrs at 6.65% in May 2024, its locked in until May 2026, and now in September you’re seeing the same 2yr fixed rate for 5.69%. You’re only 4 months in still have 1yr and 8mths remaining – you’re currently losing money (fast) on that two-year rate and the longer the rates decrease, the more you’re losing – but can I exit and refix at a shorter term?

In theory not as if you could just exit without covering your costs, obvious arbitrage would exist as you have around 600 days remaining at a rate differential of c1% and the bank will pass on their costs of a rough guestimate of $16K - $20K on a $1M loan or worse to exit (I’ve seen some dramatic examples recently).

Is there any way to level the playing field?

Some good news/relief is yes (sometimes)! The game changer is receiving either two forms of cash from the bank:

1. Retention cash – some banks will pay retention cash to do just that – retain your business

2. Refinance incentive cash – every bank will pay you money to be their customer – the general going rate is 1% of your loan balance at present (changes without notice)

The caveat to receiving cash from the bank is they want you to remain their customer for in general 3yrs so if you repay said lending, you’re on the hook to repay the cash they paid you or part thereof, timing dependent (story for another day).

But at this point it’s not a bad prospect to relieve that cognitive dissonance regarding the elevated 2yr rate by mitigating break costs with cash from the bank and sometimes even come out ahead (with more cash than you started, a better interest rate and short-term positioning).

But how do I know if it’s the right move to break out, receive cashback and refix at a lower rate?

There are so many variables and is a good trigger to a conversation with a qualified Financial Adviser (preferably Hawkeye). For example, we’ve recently had a client with break costs around $9K between two banks; both of whom were refusing to pay retention cash or even entertain a better rate on breaking without firstly sighting a competitors offer (talk about playing with fire).

Said client was also over secured with both banks (to the tune of $3M) and had a medium-term goal of both: a. releasing unnecessary properties (discharging without mortgages/unencumbered) and b. increase revolving credit limits on remaining equity.

So, we did just that and received an approval with $15K refinancing incentive cash from a competing bank whilst considerably increasing revolving credit and discharging two of the clients most valuable properties on refinance.

The client was elated as not only are we repositioning the loans at much shorter duration, but we are also discharging two securities, considerably increasing credit facilities, receiving $15K cashback to offset break costs and client gets to exit from the two banks who refused to entertain any form of goodwill payment to such a long term and loyal client of exemplary quality.

This example did make financial sense as it achieved a few goals, would come out ahead of the cash/cost game and now has bragging rights of two valuable properties that do not have mortgages not to mention exiting the two banks who were certain the risk of client “defection” was nominal - #winning.

It’s not always fun and games though and should always be discussed with your Adviser.