How low will interest rates go?

The Reserve Bank has just dropped the Official Cash Rate (OCR) by .50% for the second time this year to a record low of 1.00%, If these cuts were passed on to borrowers in their entirety, you could expect to mortgage interest rates closer to 3.0%

But as more cuts have happened, less of the reduction has been passed through to the rate borrowers pay. When the Reserve Bank last cut the official cash rate by 25 basis points, only about half of that drop flowed through to mortgage interest rates. Where the official cash rate goes does not mean mortgage rates are going to follow, the closer to zero the official cash rate gets, the less of an impact it has on mortgage rates.

This is because banks need to attract local deposits to fund the mortgages. There is only so much money banks can borrow offshore without their credit rating been downgraded. Currently about 72% of bank funds are sourced domestically. The banks need to offer rates that makes it worthwhile for people to put their money in the bank. With the recent reductions in term deposit rates banks have already seen the growth in deposits slowing down. If term deposit rates fall too low people start to look at other options which then starve the banks of funds and reduces how much they can lend.