How Do Banks Set Their Mortgage Rates?

The media often talks about predicted OCR rises (and there have certainly been a few recently) – followed quickly by discussion of mortgage rate increases. We thought it would be useful to explain how the OCR and other factors impacts how the banks set their mortgage rates. These are the main ones:

The affect of the Official Cash Rate (OCR) on your mortgage

Banks and other lenders need to acquire funds to lend out. Although these can come from a number of sources, the main source is the Reserve Bank. They set the official cash rate (OCR) which is the fixed rate at which banks can borrow capital.

The Reserve Bank periodically reviews the OCR in line with the current economic climate. As this impacts the cost your bank has to pay, it directly effects how much they charge you in interest.

Other lenders also impact your mortgage

Your bank will also borrow money from people with Term Deposits and international money markets. Similarly, the costs associated with this borrowing will be passed on to you and impact your mortgage rate. Essentially, the more it costs the lender to borrow money, the higher your mortgage rates will be.

The impact of economic conditions on your mortgage

Both the global and NZ economic situation has an impact on interest rates. The high rates of inflation we’ve seen recently has resulted in the Reserve Bank taking measures to control this. By increasing the OCR, they are hoping to bring inflation back within the recommended range.

Global interest rates, financial markets and political events along with the economic climate of major trading partners like China, the USA and Australia can also impact mortgage rates.

Assessing your mortgage risk

When you complete your mortgage application, lenders assess your credit score, income and property value. This helps them determine whether you are a high or low risk customer. Having a higher risk profile might result in a higher mortgage rates to compensate for the increased risk.

Competition between the banks

Of course, there is competition between the banks for mortgage customers. This can have a positive impact on interest rates as banks compete with each other.

Bank costs are reflected in your mortgage interest rate

Banks are businesses. They need to factor in their costs such as staff wages, rent, marketing, tax, hedging risks and making a profit for their shareholders. All these get priced into your interest rates.

As you can see, although the OCR is a significant factor, there are also a number of other factors that contribute to your interest rates. However, these changes don’t all effect different terms equally (e.g. the one year versus two year rate). When it comes to planning your mortgage terms and refixes, it pays to talk to someone who is up to date with the latest in the markets. Reach out to us if you’d like to discuss your options.