A study by New Zealand’s Reserve Bank reveals a significant proportion of borrowers are vulnerable to a material increase in mortgage rates.
A sharp and unexpected rise in mortgage rates could see the most vulnerable households default, sell their houses or reduce consumption to repay debt. That could potentially risk the nation’s financial stability, the central bank said.
The study has parallels in Australia, which shares the same banks, a frothy housing market and highly indebted households.
The Reserve Bank of Australia has also warned of financial stability risk from record household debt levels while the banking regulator has put in place new rules to tighten mortgage lending.
In fact Altair Asset Management, an Australian fund manager, has decided to liquidate its Australian shares funds and return “hundreds of millions” of dollars back to its clients, citing an impending property market “calamity”.
The RBNZ said:
New Zealand is particularly vulnerable to a sharp rise in mortgage rates as the banking system funds a large proportion of its mortgage credit from offshore wholesale markets. The cost of this funding can increase sharply if there is an unexpected increase in global interest rates or a change in investor risk appetite, and banks are likely to pass on the higher funding costs to customers through higher mortgage rates.
The Reserve Bank conducted a simple stress test of current owner-occupier borrowers to an increase in mortgage rates to 7% and 9%. An interest rate of 7% is close to the average two-year mortgage rate over the past decade, whereas 9% provides a more extreme but still plausible scenario, it said.
The stress test, as this chart shows, revealed about 4% of all borrowers, representing 6% of the overall stock of mortgage debt and 9% of recent mortgage debt, could not meet their essential expenses if mortgage rates were 7%:
A further 2% of all borrowers and 7% of recent borrowers would only have a small buffer for discretionary spending after meeting their mortgage payments and essential expenses.
Stress would be much higher at a 9% mortgage rate, with 7% of all borrowers and 18% of recent borrowers expected to face severe stress, the RBNZ said.
Borrowers in Auckland, which has seen the biggest rise in home prices, appear particularly vulnerable to higher mortgage rates. Around 5% of existing borrowers in the city are estimated to face severe stress if mortgage rates were 7%, compared to 3% of borrowers outside of Auckland, it said.