Everything you ever wanted to know about the OCR and your home loan rate, but were too scared to ask!
May 29th, 2020
The plummeting OCR is in the news a lot recently and you might be wondering, why do I pay 2.75% (or more!) on my home loan when the RBNZ’s OCR is only 0.25%? And what good are all these plummeting home loan rates if I’m locked into a high rate that I fixed 6 months ago? And finally… what’s up with all these acronyms? Well… allow us to explain 😊
The RBNZ’s OCR… sorry, the Reserve Bank of New Zealand’s Official Cash Rate is the interest rate that local banks pay the Reserve Bank when they wish to borrow money. It is also the interest rate that the Reserve Bank will pay a bank who wishes to deposit money with the Reserve Bank. The RBNZ has 7 meetings per year where it reviews the OCR and makes changes if necessary.
Currently the OCR is 0.25%, but that doesn’t mean you get to borrow money at that rate to buy a house! In practice the RBNZ charges local banks 0.50% over the OCR to borrow money, so XYZ Bank might borrow from the RBNZ at 0.75%, then XYZ Bank will add a margin (typically 2%) to that rate when lending to a home buyer. That 2% margin is not all profit for XYZ Bank. The bank will obviously incur costs in providing this service to the home buyer, and the home buyer poses some credit risk to the bank, for which the bank will need to charge.
The flip side of falling home loan rates, is that deposit rates move lower in tandem. As deposit rates move lower the attraction of putting your money in the bank decreases. The thinking is that instead of receiving some small monthly interest you might instead decide to spend or invest that money somehow - perhaps do some home renovations, buy some shares paying an annual dividend, book a holiday, or even put your savings towards a deposit for an investment property.
Now, the fact that local banks receive a mere 0.25% interest on deposits with the RBNZ means these banks will be more motivated to lend to its commercial or private customers, whom they can charge 2.5-5% over the OCR. If local banks are more willing to lend to businesses and individuals then in normal circumstances we would expect the economy to grow as businesses invest more and individuals spend more.
This is exactly what the RBNZ is trying to achieve with all its recent rate cuts.
What does this all mean for home owners and property investors?
Well, its great news on many levels. Cheaper borrowing costs mean lower monthly loan repayments which means more money in home owners’ wallets and makes investment properties more profitable. However, you won’t be paying lower monthly loan repayments if, like most, your home loan is on a fixed interest rate.
What are my options if I am locked into a fixed home loan on a high rate? Should I break my fixed rate loan?
Of course, you can break your fixed rate loan early, but your bank will charge you for this. The good news is that Kiwi banks are legally not allowed to profit from any break charges that they charge, but each bank funds at different rates so charges will vary from bank to bank. To get an estimate of your break fee you can use a calculator like this one but you will need to speak to your bank to get the actual cost.
The key point is that you shouldn’t be put off by a chunky break fee. In some cases (more often when you are close to the end of the fixed term) the savings will outweigh the costs, and it makes economic sense to break the loan and restructure on the new lower rates available today.
However, in the current economic environment and with the RBNZ providing guidance that the OCR will remain at 0.25% or lower until at least March 2021, there is no great rush to break fixed term loans as these low home loan rates are here to stay.
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