Why is a two-year home loan rate cheaper than a one-year rate?

Borrowers trying to decide what term to fix their home loans for at the moment could be scratching their heads.

At the big four banks, one-year home loan rates are currently more expensive than two-year rates, the opposite of what most borrowers are used to.

One-year rates vary from 6.49% to 6.59% and two-year rates from 6.49% to 6.79%.

Why the change? There may be a few reasons driving the difference.

READ MORE:
* Biggest bank cuts home loan rates
* ASB cuts long term mortgage rates, but short term rates will cost more
* Reserve Bank may be forced to ‘keep hiking until something breaks’

Markets pricing in future interest rate cuts

One is the underlying rates paid by banks to borrow the money on wholesale markets.

ASB senior economist Chris Tennent-Brown said the two-year swap rate is currently lower than the one-year rate, because markets expect that in a year’s time, rates could be starting to fall.

“What that is capturing is the fact that economists and market participants in the wholesale space are buying into the idea that the Reserve Bank is going to take the official cash rate (OCR) above 5% but they’re also starting to think it’s usually about a year from the peak to the start of an easing cycle.

“So that’s driving that inversion in the curve and the one-year swap rate is quite a bit higher than the two-year swap rate.”

Infometrics chief forecaster Gareth Kiernan said longer-term swap rates had been cheaper than short-term rates since mid-November. That had also helped to bring down significantly longer home loan rates, such as five-year fixes.

It was likely to continue because markets were expecting a recession, and for rates to have to fall, but the Reserve Bank was pushing up the short-term rate in the meantime with its OCR increases.

He said borrowers should be wary about fixing for longer, even if it looked more attractive. “It might be better in the short term but in a year or two you could be feeling it.”

Discounting

Tennent-Brown said the two-year rate was also one that was popular with borrowers, so banks competing for business would often try to make theirs as attractive as possible.

“A lot of people like fixing for two years. It’s a good place from a customer’s perspective for banks to sharpen up their pencils. Over the years I’ve seen the 12-month, 18-month and two-year rate all having their moment in the sun for no real reason apart from that’s where the bank wants to lend and people want to borrow.”

He said there had been times when discounting had become so fierce that rates were advertised on which banks were losing money.