The Reserve Bank of New Zealand has released its latest Financial Stability Report, revealing that households in the country will be devoting an estimated 18% of their income to interest payments by mid-2024. This figure is almost double the 2021 requirement. Some households may already be under more financial strain due to interest rate hikes than what official data suggests. The report also highlights the growing risks to New Zealand’s financial system, particularly the increasing “pockets of stress” for highly indebted households facing escalating interest rates.
Christian Hawkesby, the Deputy Governor of the Reserve Bank, stated that while the majority of borrowers have been able to manage the increased mortgage repayments so far, there are still those who are struggling and falling into arrears.
The central bank noted that two-thirds of the mortgage debt that initially benefited from extremely low interest rates during the early stages of the pandemic has since rolled over. The effective mortgage rate, a measure of the average interest paid across all home loans, has risen from a low point of 2.9% in late 2021 and is projected to hit 6.4% by the middle of next year.
Certain groups of borrowers are feeling the impact of these higher interest rates. These include households that took on high debt-to-income ratio mortgages when the housing market was peaking and interest rates were below 3% during 2020 and 2021. Households that borrowed at these high ratios are potentially at risk, with their estimated debt servicing ratios predicted to rise to around 50% by late 2023.
The Reserve Bank cautioned that despite strong growth in household incomes in recent years, further increases in interest rates could lead to a significant rise in loan defaults. The bank also highlighted that the impact of these defaults will largely depend on the labour market’s strength. If the labour market remains robust, with wage growth and low unexpected unemployment, wider implications would likely be limited.
The central bank explained that the arrears seen so far have been largely due to unforeseen individual events such as illness or job loss, rather than solely because of increased interest rates. However, the bank warned that a portion of lending is still set to adjust to higher interest rates, which will inevitably lead to more financial hardship for some borrowers.
In previous cycles, households juggling multiple forms of debt prioritised their mortgage and utilities payments over other debt types. Recently, borrowers with a mortgage and other forms of debt have been missing repayments on non-mortgage debts more than non-mortgaged borrowers, implying that the debt servicing strain on mortgaged households could be more severe than what mortgage arrears alone suggest.
The Reserve Bank also highlighted that banks are expecting non-performing loans to more than double, reaching 1% of lending by 2025.
The rise in house prices over recent months has been partly attributed to a surge in migrants entering New Zealand. The Reserve Bank also noted that while short-term mortgage interest rates continue to rise, longer-term rates have largely stabilised over the past six months. Despite a slight increase in the test interest rates used to assess prospective borrowers’ repayment ability, borrowing capacity for buyers has largely remained intact.
The ratio of house prices to incomes has also declined nationally to about nine times from 11, and in Auckland, it has returned to 2013 levels. Looking ahead, the Reserve Bank emphasised that there is significant uncertainty surrounding future lending stress. The unique blend of high interest rates and low unemployment is unprecedented in recent history, which could alter the pattern of lending stress compared to what is currently projected.
