Explained: how will banks’ mortgage stress-test rates change?

Mortgage applicants currently need to convince ANZ, New Zealand’s largest bank, that they can repay their loans at an interest rate of 6.7%. ASB sets an even higher test rate of 6.85%. These figures are considerably above the two banks’ current standard fixed mortgage rates for terms of 1 to 5 years, which range from 4.49% to 6.45%. ASB says it is reviewing whether its test rate is appropriate in response to interest rate changes following the recent OCR increase. ANZ gave a more general statement, saying its test rate is “reviewed regularly in light of the changing interest rate environment”. Other major banks—BNZ, Kiwibank and Westpac—declined to disclose their test rates, saying only that they also review them regularly.

{ad}

Why stress-testing mortgage applicants matters

 

Inflation beginning with a “7” for the first time in 30 years may already have put unprecedented pressure on our living costs. But for those of us with mortgages, the potential threat when refixing with the bank is far more frightening. Let us make a simple comparison:

In May 2021, the average mortgage was $329,000 over 30 years, with a one-year fixed rate of 2.25% and monthly interest payments of $1258.

When the mortgage is refixed a year later, the new one-year rate is 4.55%, with monthly repayments of $1677—an increase of $419 a month.

In May 2021, the average first-home buyer mortgage was $548,000 over 30 years, fixed at 2.25% for one year, with monthly repayments of $2095.

When the mortgage is refixed a year later, the new one-year rate is 4.55%, with monthly repayments of $2793—an increase of $698 a month.

 

Note: these examples were calculated using ANZ’s and BNZ’s current market mortgage rates.

 

To be clear, the issue is not that current interest rates are particularly high in themselves, but that they are frightening for many borrowers with seven-figure loans. For example, in 1991, mortgage rates were 12%, but with average house prices then a little over a hundred thousand New Zealand dollars, borrowers faced less repayment pressure than they do today.

The Reserve Bank of New Zealand has made it clear that its current goal is to tackle inflation. High interest rates act like a “punishment”, and as more homeowners refix their mortgages, some will feel that punishment. Of course, mortgage holders also still face inflation of 7%. Inevitably, some will say nobody forced anyone to buy a house or take out these enormous mortgages. Entering the market involves risk, and investors must bear the consequences. Fair enough, but for New Zealanders hoping to own a home, you can never extinguish a Kiwi’s determination to buy. In these circumstances, the importance of stress-testing mortgage applicants speaks for itself.

 

How much further could test rates rise?

There is no doubt that if the OCR and mortgage rates continue to rise, test rates will rise too. Banks generally calculate their test rates by adding a percentage margin to their average one-year mortgage rate, so test rates could exceed 7% in future. Reserve Bank of New Zealand (RBNZ) data shows that between 2017 and 2021, the gap between the average 1-year mortgage rate, currently as low as 4.19%, and banks’ average test rate was 2–4 percentage points. Similarly, between 2018 and 2021, the gap between the OCR, currently 1.5%, and test rates hovered around 6 percentage points.

For example, an applicant seeking to borrow NZ$500,000 over 30 years would need to convince the bank that they could repay NZ$806 a week at a test rate of 7.5%. That is NZ$62 more a week than at ANZ’s current test rate, and NZ$249 more a week than repayments at a mortgage rate of 4.1%.

The Reserve Bank of New Zealand expects the OCR could peak at 3.4% during this tightening cycle. Add 6 percentage points to that... and banks’ test rates would be unimaginably high...

 

Could the Reserve Bank of New Zealand set a minimum bank test rate?

To address the issue of excessively high test rates, the Reserve Bank of New Zealand is considering setting a minimum mortgage test rate for banks. It consulted on this between November last year and February, and may reveal more details when it releases its Financial Stability Report on 4 May.

The proposal aims to address short-term financial stability risks while the Reserve Bank works with banks to establish a debt-to-income (DTI) restriction framework. The Reserve Bank of New Zealand says it could introduce a minimum test rate sometime between April and June as an interim measure, with DTI restrictions implemented by the end of this year. However, it says minimum test rates and DTI restrictions are unlikely to operate simultaneously. The Reserve Bank also says it favours adding a fixed buffer to a benchmark interest rate. Although it notes that the OCR is closely linked to mortgage rates, longer-term rates, such as 5-year or 10-year swap rates, may better reflect long-term interest rate trends. Test rates could be reviewed quarterly.

The Reserve Bank of New Zealand favours ensuring that test rates remain stable over a period, adjust automatically and apply equally to all mortgage applicants—investors, existing owner-occupiers and first-home buyers. It recognises that this policy would hit first-home buyers particularly hard, so it proposes using a minimum test rate only as a temporary measure before DTI restrictions are introduced. The Reserve Bank has long wanted to introduce debt-servicing restrictions. In any case, its lending restrictions are intended to support the stability of the financial system as a whole, rather than specifically to control house prices.

 

Disclaimer: the views above do not represent YIJU’s position. YIJU accepts no legal liability.