The Reserve Bank has hiked the OCR, but that doesn’t mean your mortgage rates simply move by the same amount. From swap rates and wholesale funding to customer deposits and bank competition, there’s a lot happening behind the scenes when banks decide what borrowers will pay.
1. How the OCR Influences Mortgage Rates
The OCR is the factor most borrowers hear about when mortgage rates are in the headlines, and for good reason. It provides a general indication of where interest rates are sitting across the economy, but its impact differs depending on the type of mortgage rate.
Floating rates tend to move more directly with the OCR. Fixed rates are influenced by it, but their pricing also reflects what markets expect to happen in the future.
This is why banks can sometimes change fixed rates before an OCR announcement. Expectations about what the Reserve Bank will do may already have been reflected in wholesale markets and swap rates before the official decision arrives.
The OCR itself is essentially the rate banks can access as a lender of last resort through the Reserve Bank. Banks then need to account for their own costs and margins when determining what they ultimately charge borrowers.
2. Why Swap Rates Matter for Mortgage Rates
While the OCR dominates the headlines, swap rates are another important influence on mortgage rates, particularly when looking at fixed lending.
Swap rates are essentially short-term funding rates between banks. If a bank is short of money, it can access funding through this interbank market.
What makes swap rates particularly useful is that they reflect the market’s expectations for where interest rates are heading. If the market expects rates to rise, swap rates can increase. If expectations are for rates to fall, swap rates can move lower.
That means movements in these markets can give an indication of where interest rates could be heading before those changes appear in an OCR announcement.
3. The Cost of Wholesale Funding
Banks don’t only source money locally. They can also access funding from large financial institutions around the world.
This wholesale funding market can include banks selling packages of mortgages to other institutions. For example, a bank could bundle $500 million of New Zealand mortgage lending together and offer it to the wholesale market at a particular interest rate.
If that return isn’t attractive enough to potential buyers, or they see greater risk in the New Zealand market, the bank may need to offer a higher rate to attract investors.
That cost of accessing money ultimately becomes another factor banks need to consider when pricing their lending.
4. What Customer Deposits Tell Us
Some of the money banks lend also comes from their own customers through savings accounts, term deposits and other cash facilities.
Term deposit rates can therefore provide another useful indication of where interest rates are sitting.
If mortgage rates increase but term deposit rates don’t follow, that movement may not necessarily represent a new longer-term level for rates. But if mortgage rates and term deposit rates both increase, Mike suggests that can indicate the higher rate environment may be sticking around for a while as banks seek to protect their margins.
5. Bank Competition and Profit Margins
The final piece is something banks have more direct control over: their own margins.
Banks can price their lending up or down depending on their funding position, profitability and how aggressively they want to compete for new business.
Cashback offers are one example. They can reduce the margin a bank earns during the first years of a loan, and Mike questions whether the days of large cashback offers could become less common if banks come under greater pressure to improve their margins.
Competition matters too. Banks want market share, while challenger banks and non-bank lenders are also participating in the lending market. Fewer lenders could mean less competition, which is why changes to the number of institutions operating in New Zealand can also matter for borrowers.
What Does the Latest OCR Hike Mean for Borrowers?
So, does the latest OCR increase mean mortgage rates are automatically about to rise by the same amount?
Not necessarily.
The OCR gives borrowers an indication of the direction rates may be heading, but how far and how quickly mortgage rates move depends on the other factors influencing the banks at the same time.
Mike expects banks to be relatively quick to pass on this latest increase, in part because he believes they’re looking to improve their margins. However, he doesn’t expect the increase alone to have a significant impact on the property market, with rates still at what he considers reasonable levels.
For the average borrower, that doesn’t mean you need to start monitoring wholesale funding markets every morning. Understanding the fundamentals can help explain why rates are moving, but trying to predict every movement yourself can quickly become complicated.
Key Takeaways
- The OCR matters, but it isn’t the only factor determining mortgage rates.
- Floating mortgage rates tend to be more directly affected by OCR movements than fixed rates.
- Swap rates reflect market expectations about where interest rates could be heading.
- The cost of accessing wholesale funding can influence what banks need to charge borrowers.
- Customer deposits are another important source of bank funding, making term deposit rates worth watching.
- Banks also have control over their margins and how aggressively they compete for new lending.
- Mortgage rates can move before an OCR announcement if markets have already priced in the expected change.
- Rather than trying to follow every variable yourself, speaking with a mortgage broker can help you understand what changing rates could mean for your situation.
Next steps:
If you want to understand what changing mortgage rates could mean for your home loan or next property move, speak with Mike and the Lighthouse Mortgages team.
If you’d like to watch more, check out this episode below.
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Disclaimer:
The information in this article is general information only, is provided free of charge and does not constitute professional advice. We try to keep the information up to date. However, to the fullest extent permitted by law, we disclaim all warranties, express or implied, in relation to this article – including (without limitation) warranties as to accuracy, completeness and fitness for any particular purpose. Please seek independent advice before acting on any information in this article.
