This week NZ Adviser’s provocative headline announced: “7% mortgage rates could collapse the housing market,” with the article going on to cite the recent May Financial Stability Report from the Reserve Bank of New Zealand.
Although the headline “7% mortgage rates could collapse the housing market” is definitely just an attention grabber, as there is no evidence this is about to happen, it is a good reminder to prepare yourself for the unexpected, especially when borrowing.
The report released an assessment of ‘stress tests’ designed to assess the vulnerability of households to service their mortgages if rates were to unexpectedly rise. The analysis suggests that if there were to be a rate rise - a significant proportion of New Zealand borrowers would be vulnerable.
“A sharp and unexpected rise in mortgage rates could see the most vulnerable households default, sell their houses or reduce consumption to repay debt. Recent borrowers in Auckland and borrowers with high DTI (debt to income) ratios appear most vulnerable, signalling that a continued high share of lending at high DTI ratios is concerning and may present a risk to the housing market and financial stability.”
It’s not surprising that the Reserve Bank has been trying to have debt to loan restrictions made available as one of its tools to control the housing market. Also not surprising that Auckland borrowers appear the most vulnerable.
Nowadays, banks have much more regimented testing, but it’s always best to calculate your borrowing ability based on unexpected higher rates. This is not just in case higher rates were to happen, but also to ensure you could afford to keep paying if rates were to remain the same, but something unexpected were to happen in life. Whilst interest rates still hover around the mid 4% to mid 5% range, I suggest using a rate closer to 7.5% when calculating your household budget.
Slowly but surely the banks have been pulling back on how much they lend you, even using a rate as high as 7.8% in serviceability tests. As a rough guide, if your deposit is less than 20%, your borrowing power will be roughly 3.5 x to 4 x your gross income per annum. With 20% or more deposit, it could be around 5 x your gross annual income as a possible loan size. This doesn’t take into account variables though such as existing debt, age and dependants. Banks’ online borrowing guides tend to be a bit misleading because of all the variables involved so always double check with a mortgage adviser as to your borrowing power. Also how best to fit your desired loan with your budget and lifestyle.
Contact us to talk through your options.