STRESS TESTING — THE DOOMSDAY SCENARIOS

One lesson from the Global Financial Crisis is that things can change, and fast. People quickly forget that floating interest rates were around eight percent less than 20 years ago and that two-year fixed rates in 2007 rocked up to 10 percent. Heck, back in 1987 they hit 20 percent. Today’s five percent two-year fixed rate is the lowest this century.

In the same way that the Reserve Bank looks ahead to create hypothetical scenarios of things that could affect a healthy banking system, home owners would do well to check how well they could cope with even a one percent hike in mortgage interest rates.

The Bank’s November financial stability report points out that high debt levels mean New Zealand households remain vulnerable to financial risk, especially those that have only recently bought houses, as well as property investors. Borrowers could be stressed if there were an economic downturn or significant increase in interest rates.

The Bank also says that house prices still being high relative to incomes increase the chance that house prices could fall significantly in the future, making it harder for households to sell their houses to pay off their debts. Last year, the Reserve Bank asked the country’s four largest banks to model what could happen if a downturn in the Chinese economy caused a fall in New Zealand exports, or unemployment went up, or house prices fell. Householders could well do the same to test their own vulnerability to changes.

OneRoof and Valocity have modelled what could happen to mortgage repayments if interest rates move from five to ten percent. We calculated repayments on a 30-year mortgage, based on a 20 percent deposit, for properties bought at today’s median values, and compared them to repayments on properties bought at 2014 prices.

As you would expect, there is increase in exposure for those who purchased later in the cycle.

People in Auckland, Tauranga and Wellington who bought now are paying more than $1000 a month than 2014 buyers.

Add changes to interest rates - banks do their loan approval calculations based on a two percent increase - and monthly repayments quickly soar. Median repayments for properties in Auckland, go up by over $1000 a month, nearly $800 in Hamilton, over $600 in Tauranga.

And that’s just median values, so there would be bigger jumps in higher value suburbs.

A jump to nine or ten percent interest rates, and most Auckland mortgagees would struggle to find spare sums of more than $2100 or $2700 a month. Even in Dunedin, homeowners would have to find nearly $900 to $1100 extra a month.

In 2017, the Reserve Bank did its own stress tests as part of its regular financial stability report. It’s important to the bank as defaulting borrowers can prompt financial instability with a flood of houses to the market or cutting their consumption.

Using assumptions about essential living expenses and the reliability of income sources, the Bank looked at the how much stress an interest rates rise to seven percent would cause for household budgets. They found that four percent of borrowers (who hold six percent of the debt) would be severely stressed - that is, they couldn’t meet their living expenses.

A further two percent of all borrowers, but seven percent of recent borrowers, would have only a small financial buffer and would be classed as mildly stressed.

If rates ballooned to nine percent, seven percent of borrowers and a significant 19 percent of recent borrowers would suffer severe stress, more so in Auckland.