Understanding the Home Loan Interest Rate Curve and how to choose the right Fixed Rate Tenor for You
Of course there are various factors affecting which tenor suits you best. Some will like the security of knowing what your monthly home loan repayment will be for the next 2, 3 or even 5 years. Others will have a higher risk appetite, be more motivated by dollars and cents saved and therefore be more interested in the front end of the curve.
The ‘front end of the curve’ means any tenor from floating to 1 year, but realistically this boils down to the 1 year rate as it’s the most liquidly traded date in the Interbank market and therefore offers the best value to retail customers like you and I.
How can you best assess the relative value of different maturity dates? Is the 1 year rate ‘better value’ than 2 year?
One useful tool when comparing the merits of the 1 year versus 2 year interest rates is to calculate something called the ‘1 year in 1 year forward interest rate’.
In plain English, this means figuring out what the 1 year interest rate will be in 1 year from now. To avoid getting bogged down in the maths we can use a quick and dirty calculation to figure it out. Here is an example using interest rates generally available today:
Today’s 1 year interest rate = 2.50%
Today’s 2 year interest rate = 2.65%
What does this imply for the 1 year interest rate in 1 year’s time?
It implies a rate of 2.80% (rough maths is (2.65-2.50) + 2.65 = 2.80%)
Now, do you think that the 1 year interest rate in 1 year’s time will be more or less than 2.80% when you consider the rhetoric coming out of the RBNZ and predictions of further falls in the OCR?
Personally, I find it unlikely that the 1 year rate will jump 0.30% or more over the next 12 months, choosing to stay away from 2y and fix for 1 year instead.
Please note we are not financial advisors so we are not mandated or qualified to offer financial advice. However, if you would like to broadly discuss interest rates and exchange ideas then please get in touch with me on 02108226261 or firstname.lastname@example.org