Everything you ever wanted to know about the OCR
The rapidly rising OCR is in the news a lot right now, and you might be wondering, why do I pay 5% (or more!) on my home loan when the RBNZ’s OCR is only 3%? Also, my low home loan rate is rolling off soon, should I break that fixed rate agreement and re-fix for another year or two before the OCR goes up even more? 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.
The RBNZ has 7 meetings per year where it reviews the OCR and makes changes if necessary. The next two meetings are on 5th October and 23rd November.
What is the RBNZ aiming to do by changing the OCR?
The RBNZ’s remit requires it to keep inflation between 1 and 3% on average over the medium term, with a focus on keeping future average inflation near the 2% target midpoint and supporting maximum sustainable employment.
Importantly for property owners and investors, the OCR directly influences the interest rate on your home loan.
Currently the OCR is 3%, but that doesn’t mean you get to borrow money at that rate to buy a house! In practice the RBNZ charges local banks roughly 0.50% over the OCR to borrow money, so XYZ Bank might borrow from the RBNZ at 3.5%, 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 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 rising home loan rates is that deposit rates move higher in tandem. As deposit rates move higher, the attraction of putting your money in the bank increases. The theory is that as deposit rates increase you might decide to put off investing or spending your money, and instead opt to receive some monthly interest from your bank.
More money being squirrelled away on term deposit means less money is chasing the goods and services available in NZ, causing price growth to slow down.
That is exactly what the RBNZ is trying to achieve with all its recent rate hikes.
What does this all mean for homeowners and property investors?
Borrowing costs are the largest cost that a property owner or investor generally face. So when the cost of borrowing increases, you can imagine the knock on effects for property owners.
Property prices still remain elevated (despite the much-publicised) fall in prices, so borrowing money now to buy rental properties is currently not attractive for many property investors.
Agents up and down the country are reporting much very low levels of investor activity – which makes sense.
More generally though, investors are not as exposed to higher interest rates as you might think. Investors generally have very low levels of debt (having been in the game long enough to benefit from huge lifts in property prices) and they also will have been able to fix their loans at the low rates seen in 2021.
So I would not expect much in the way of panic selling from investors struggling with new high loan rates.
What if you are on a low home loan rate now, but you have to re-fix soon and are concerned about predicted rises in the OCR? Should you break your fixed rate loan now, before the OCR rises again?
If you’re thinking about breaking your fixed rate loan early then the good news is that Kiwi banks are legally not allowed to profit from any break charges that they charge.
That said, each bank funds at different rates so charges will vary from bank to bank.
In this environment you should get paid by your bank to break early but you’ll need to check with your bank and weigh up the costs and benefits of breaking before making a decision.
In practice, another 1+% hike in the OCR largely priced into current home loan rates on offer, so the juice that you give up by breaking early is likely not offset by grabbing the current 1y or 2y loan rate.
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