It is impossible for anyone to predict future interest rates with certainty. The big corporate and financial institutions spend considerable time and money in forecasting interest rates.
Still their record of forecasting is notoriously poor. I have been advocating splitting of loan and fixing for different maturities in my previous columns. I am still a strong advocate of the same. But there are certain points worth considering here. Notable ones are
· RBNZ Governor has reiterated that the OCR will stay low for next few months.
· US Federal reserve chairman has also indicated the same.
· On the other hand Australia has already increased OCR by 50 basis points in last couple of months. It is expected that Australian economy will beat other world economies in terms of growth and the interest rates will rise further.
We should remember that in New Zealand as well as in rest of the World, the interest rates were dropped sharply in response to economic conditions during last 1year or so. There is always risk that if the situation demands, these can be increased sharply.
If we look at the fixed interest rates for different maturities at present (at the time of writing this column on 8.11.09), we see that 12 months fixed rate is close to 6%, 24 months close to 7% and 36 months close to 8%.
Now the question is for how long one should fix the loan for?
If you fix the loan today for 12 months at 6% and after 12 months, you get a rate of 8% for re fixing for next 12 months, your average for 2 years will be 7% and that equals the fixed rate for 24 months at present.
Similarly if you fix the rate today for 12 months and after 12 months, you get a rate of 9% for re fixing for next 24 months, your average for 3 years will be 8% and that equals the rate for 36 months at present. Similarly it can be calculated for rates for other maturities. (There is no certainty as to how much the rates can move up in one year’s time)
But considering what the RBNZ Governor is saying, you can decide to fix for up to 12 months today and exposing yourself to risk of higher rates in future, thinking that interest rates may not rise by 2% in next 12 months.
That is if you are a risk taker and can afford to pay higher rates in future. If you are too conservative, want certainty and do not want to take any risk, fixing for longer term may be better. The middle policy is of course splitting and fixing for different maturities.
Another aspect to look at is your present family income and expected future family income. If your family income is low at present and it is expected to go up in future, you may choose to fix for a shorter term now, so that your repayment is lower and fix at potentially higher rate in future, when your income may be higher. Your income may be low at present due to redundancy, being a student, being on maternity leave, etc.
Everyone has different financial circumstances, different risk profile and also different risk taking capacity. This article is for general guidance only; you should seek independent financial advice before acting on the same.
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