If you have been following the news recently then you would have heard lots of mentions of the Official Cash Rate, or the OCR as it's commonly referred to.
The OCR is a very important piece of the financial landscape in New Zealand, but do you know what it is and how it affects you as a property investor?
The Reserve Bank of New Zealand (RBNZ) defines the OCR as "the interest rate set by the Monetary Policy Committee". This is a fancy way of saying that the OCR is a policy that the RBNZ uses to influence the price of borrowing and saving money in New Zealand.
The OCR is reviewed seven times per year by the RBNZ and every review comes with much speculation from investors because it has a direct influence on their financial position.
In essence, if the OCR is raised or decreased, the cost of borrowing will change too and this will influence how New Zealanders manage their money.
For example, if the cost of borrowing money (i.e. interest rates) is high, people tend to spend less money and save more because they can receive a higher rate of return.
What this does is actually slow down economic growth.
This contraction might seem counter-intuitive because generally speaking, we want the country's economy to grow, but this is a way to combat high inflation rates.
Inflation stems from high levels of spending and low levels of saving, so if the RBNZ makes saving more attractive due to higher interest rates, inflation should in theory come under control.
This is a very relevant example in times like this where inflation is high and the RBNZ needs to find ways to reduce the impacts high inflation has on households in New Zealand.
So, how does this affect you as a property investor?
Property investors usually get mortgages on the properties they are looking to purchase.
Because mortgage rates are directly associated with the OCR level, when the OCR is raised, this generally means banks will increase their interest rates.
As with any business, cost increases are passed onto the consumer through their pricing. Meaning, when banks put up their interest rates, the rise in costs is felt by the mortgage borrowers.
Let's see an example of this:
An investor has an interest-only mortgage on their investment property of $500,000
The mortgage is currently fixed at 3% but the interest rate will change to 6% once the rate is renewed
How much is this going to change the monthly interest costs for this investor?
A $500,000 mortgage at 3% equals $1,250 per month in interest cost.
On the other hand, a $500,000 mortgage at 6% equals $2,500 per month in interest costs. So, as the interest rate goes up by 3%, the cost of the mortgage doubles.
Ultimately, the OCR is going to affect everyone in New Zealand but the policy changes are made to benefit our economy going forward.
For investors, there might be short-term losses to make up resulting from higher interest rates but the outlook is still good when looking at a 10-year plus time horizon.
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