Banks have doubled their margins on floating rate home loans

OPINION: A 1kg block of cheese has become the emblem for these inflationary times, but would we be as energised about forking out $5 more for a hit of Tasty if we had an extra $100 a week in our pockets to cover it?

Or if we had the option of a further $300 a week, or the chance to pay off our mortgages 10 years quicker, without committing an extra cent or repayments?

Instead of being distracted by high jinks in the dairy aisle, it’s about time we started to pay a bit more attention to the role our banks and our Government could play to make this happen.

The Reserve Bank Te Pūtea Matua (RBNZ) describes the official cash rate (OCR) it sets as the wholesale price of borrowing or lending money in New Zealand.

We can take from this that someone wanting to borrow money from a retail bank at a variable rate will pay something that is broadly linked to the OCR.

Helpfully, the RBNZ publishes data that tracks both the OCR, and an average of the floating rates charged by banks for their mortgage customers.

As you can see below there is indeed a clear correlation.

What the charts also show is that for most of the first decade this century, the average floating rate sat around 2% above the OCR.

However, over the last 15 years, this margin has been steadily increasing

Now it sits around 4% above the OCR.

So far, so blah economics. But things start to get very interesting when you consider the real impact of this on a typical Kiwi customer.

Let’s take a hypothetical young couple in their mid-thirties who, through a combination of their own savings, emptying their KiwiSaver accounts, and some help from the bank of Mum and Dad, manage to cobble together a $100,000 deposit on a $1.1million first home.

With their bank’s floating rate sitting 4% above the current OCR of 2%, our couple will be required to make monthly payments of $6000 for the best part of the next 30 years to pay off the loan and over that time will pay the bank approximately $1.1m just in interest payments.

This assumes that they have a floating rate throughout.

However, had the bank kept its margin at the historically lower rate of 2% above the OCR, then not only could our couple expect to pay off their mortgage in just 20 years, in doing so they would pay around $450,000 in interest

That would result in a saving of more than $600,000, or they could pocket an additional $300 a week if they chose to keep the term at 30 years.

This is a quite remarkable saving

If you look at it the other way, a quite astonishing additional profit for their bank for doing precisely nothing different.

If this isn’t enough to grab your attention, let’s add some further perspective by checking out what this means for our couple’s KiwiSaver.

Let’s say that between them our couple brings in $130,000 a year.

Having had their KiwiSaver funds drop back to zero after purchasing their home, then paying in 3% of each of their salaries, and receiving the 3% employer contribution, by the time they’ve paid off the mortgage and are eligible for retirement, our GoalsGetter tool suggests they will each have a combined balance of just over $700,000.

Our couple will have spent nearly 30 years saving hard in KiwiSaver to support themselves in retirement, and really all they’ll have managed to achieve is to save enough to cover the additional interest the bank has charged them, because it chose to double its margin on its floating mortgage rate.

And at the risk of riffing too heavily on our couple’s dire straits, it’s not just the banks that are getting their money for nothing.

While our couple will have contributed over $2m in income tax from their earnings over this 30-year period, they’ll have also had the Government take a further $160,000 from their KiwiSaver balances in tax over the same period.

There has been a great deal of focus on fees charged by KiwiSaver providers from various quarters and an emphasis on why these should be reducing over time.

As managing director of a fund manager and KiwiSaver provider, I’m a firm advocate for transparency so consumers can understand and make informed judgement on whether they are receiving value for money services.

In embracing greater scrutiny on what we do though, I would love to see this same level of rigour applied to the wider financial services sector.

Maybe the regulators for these areas of financial services, the Financial Markets Authority Te Mana Tātai Hokohoko and RBNZ, can agree on having a similar focus on ‘value for money’, as squeezing fees on KiwiSaver, whilst allowing floating rate margins to bloat, seems like straining gnats only to swallow camels.

George Carter is MD of fund manager and KiwiSaver provider Nikko AM NZ and investment platform GoalsGetter.