by Sally Lindsay
However, it is unlikely the Government will giving any handouts in this month's Budget to mortgage borrowers struggling with repayments as they roll on to higher interest rates.
Twelve consecutive hikes in the official cash rate (OCR) to 5.25% has helped house prices come off the 2021 highs and the RBNZ is widely expected to raise the OCR another 0.5% later this month, to help bring house prices down further.
The bank’s latest Financial Sustainability Report says prices are within the range of fundamental values suggested by some of the metrics it monitors, but the overall balance suggests prices remain somewhat overvalued.
“In the near term prices may continue to soften, given the level of interest rates, the ongoing completion of houses under construction, and weak market sentiment.
“However there remains the risk of house prices declining significantly below our assessment of their sustainable level, particularly if the number of distressed sales picks up, generating self-reinforcing negative feedback effects,” the report says.
Lending on mortgages
About 60% of the country’s home lending is on fixed interest rates that will roll over to higher rates within 12 months, the report shows.
About a quarter of banks’ mortgage books originating in 2021 – when low interest rates of 2-3% were available – allowed buyers to take out large mortgages to buy properties that have since fallen in value; 20% in Wellington and 18% in Auckland.
CoreLogic estimates about 2,000 recent first home buyers may now be in negative equity, with their mortgage debt being greater than the value of their home. It says if the country goes into recession, as many economists are picking, it will increase the number of homeowners sliding into negative equity.
While this may be the case, the Reserve Bank says there is not widespread distress among homeowners and businesses on the back of 12 consecutive OCR rises.
However, the bank does expect to see more mortgage holders fall behind on their payments this year as they roll on to higher interest rates.
Centrix data this week show mortgage arrears rose for the eighth consecutive month in March, with 19,300, or 1.31%, of residential mortgages past due, up 26% year-on-year.
For homeowners that borrowed between late 2020 and late 2021, current interest rates exceed some of the test rates used by banks during this period, says the RBNZ.
“Some of these borrowers and other borrowers with high debt-to-income levels may begin to struggle to meet their repayment obligations,” says Christian Hawkesby, RBNZ deputy governor. About 25% of existing mortgage lending originated during 2021, with about a fifth of this being to first home buyers.
“Based on current mortgage and swap rates, we expect the average effective interest rate on mortgages to reach 6.1% by the end of the year.”
Debt servicing costs increasing
The RBNZ says most property-owning households still have substantial equity buffers.
This has been due to a combination of the cumulative effects of past LVR restrictions that limited households’ leverage and a rise in property valuations that has added to household wealth since 2019, which has yet to fully unwind.
Nationally, house prices have returned to around the level in February 2021, says Hawkesby.
“Debt servicing costs have risen significantly from historically low levels during the pandemic. For a household with a mortgage, the share of disposable income required to service the interest component of their mortgage debt will more than double from its recent low of 9% to around 22% by the end of this year.”
He says despite the significant rise, this would still be lower than the peak experienced in mid-2008. However, this increased debt servicing burden is distributed highly unevenly, with some borrowers, such as those who fixed at the low of mortgage rates in mid-2021, seeing far greater rises in their debt servicing costs than others.
For businesses, whose lending reprices faster than households on average, much of the increase in debt servicing costs has already occurred. Most businesses have been able to absorb the increases in debt servicing costs because of deleveraging over recent years and strong economic conditions.
Hawkesby says highly leveraged borrowers are the most at risk of significant debt servicing stress.
“Although increasing debt servicing costs alongside high inflation will constrain mortgaged households’ budgets, we expect most borrowers will be able to continue to service their debt obligations without significant stress, given the servicing test buffers that banks have applied when assessing borrowers’ loan affordability and the current strength in the labour market.”
Hawkesby says two factors will lessen the degree of stress this repricing might cause.
Firstly, affordability test rates are used to determine the maximum loan amounts that applicants can afford, and many borrowers borrow less than this amount.
Secondly, nominal household incomes have grown strongly in the past two years.
“Rates of non-performing mortgages and the number of mortgagee sales are also low albeit growing.”
Banks have been proactively identifying borrowers who may face debt servicing challenges as they reprice to higher interest rates. So far they have reported relatively low numbers of customers encountering difficulties in meeting higher repayments.
Hawkesby says in part, this reflects the fact that many borrowers used the period of lower interest rates to make excess principal repayments ahead of their original schedules. These borrowers can now use this buffer to limit the rises in their repayments due to higher interest rates.
Taking time
While the RBNZ is not seeing widespread financial distress amongst households or businesses, in part this reflects the fact that the repricing of mortgage lending will take some time.
Households are also adapting by reducing discretionary spending and drawing on savings, including working with their banks to extend the durations of their mortgages where they are ahead of their repayment schedules, says Hawkesby.
“The lack of acute stress showing up in banks’ lending portfolios reflects the strength in the economy and labour market to date,” he says.
However, the RBNZ expects more borrowers to fall behind on their payments this year, given the ongoing repricing of mortgages and expected weakening in the labour market.
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