The simplest way to think about mortgage rate settings is:

• The cost of borrowing the money + some operating costs + extra profit margin = interest rate

This is why rates vary, and why they’re higher than the OCR.

Banks aren’t borrowing money at exactly the OCR rate. The money they lend comes from different sources. A big one is customers’ deposits. (For example, the bank might pay you five per cent interest on your savings account, then lend that money out at a mortgage rate of six per cent).

Banks also borrow from the Reserve Bank of New Zealand (RBNZ) and other overseas wholesale lending sources. When banks borrow from the RBNZ, they pay slightly over the OCR. This means the OCR is influential in how banks set their mortgage rates, but there isn’t a clean equation where you can just plug in the OCR to work out how high the rates will be.

The RBNZ’s own research shows:

• If the OCR changes by one per cent, after one month that will result in a 0.34 per cent change in the two-year home loan rate.

• After six months, 0.8 per cent of the one per cent change will have been priced into rates – and that’s the peak.

OCR direction

Another factor beyond just the bald OCR number is the direction the OCR is heading. Banks may anticipate a lower OCR and cut rates early, for instance. And perhaps, most importantly, banks set rates depending on what the other banks are doing. All banks are aiming to make money, and they also want to be competitive. So, when one bank cuts its rates, others will typically follow suit. The big banks are all playing a game of trying to win market share while still maintaining strong profits.

The differences between bank rates can seem minimal, but over a fixed term of two or three years, even 0.1 per cent can have a significant impact on your finances. Shop around.