The Reserve Bank of New Zealand today again raised its official cash rate (OCR) sharply, by 50 basis points to 2.5%. This is its third consecutive increase of 50 basis points this year. The Reserve Bank said the increase was intended to “continue tightening monetary policy at pace to maintain price stability and support maximum sustainable employment”.
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There is no denying that the Reserve Bank of New Zealand's current monetary tightening is accompanied by upward pressure on mortgage rates and downward pressure on house prices. As fixed mortgage rates approach 6% p.a., many borrowers are confronting an unwelcome reality: the low rates they locked in last year are gone, and when they refix their mortgages, they will have to accept rates several times those of last year. Combined with continually rising prices, this could leave many households unable to afford their increasing mortgage interest payments.
Addressing this issue, Umbrella Company mortgage adviser Sara Hartigan warned that many borrowers are expected to have to switch from principal-and-interest repayments to interest-only repayments over the coming months. Interest-only repayments may be all they can currently afford.
She explained that many people coming off very low rates cannot afford higher ones. Others have borrowed to buy a car, planned a post-pandemic holiday or renovated their property, all of which have added to their household debt repayments to varying degrees. Paying interest only may therefore be the only way they can keep servicing their mortgages.
Although banks have not yet publicly discussed how struggling mortgage borrowers will meet their interest payments, she believes both lenders and borrowers need to take the issue seriously. Most banks assess applications to switch from principal-and-interest to interest-only repayments on a case-by-case basis. However, even approval for just two years could help many households through the difficult period of financial crisis and recession. As an example, she said the change had slashed one of her mortgage clients' regular repayments from NZ$6500 to NZ$3200.
EasyStreet Mortgages mortgage adviser Gareth Veale said clients had recently asked whether they could extend their mortgage terms beyond 30 years, indicating that many people were hoping to switch to interest-only repayments as they struggled to keep their households afloat. He believes rising rates will put many borrowers in financial difficulty because their household budgets were based on last year's repayments, when rates were less than a third of current levels. People will have to consider substantial spending cuts or work with their banks to find a solution.
Total Mortgages mortgage adviser Jordan Cameron offered a different interpretation. He said interest-only mortgages were generally intended for property investors or people in financial hardship, and banks were unlikely to let borrowers switch simply because interest rates had risen. He explained that mortgage borrowers first needed a reasonably strong justification for such a change. For example, if they could not meet their repayments despite doing everything they could, the bank's hardship team might approve it depending on the circumstances. If borrowers simply phoned to request interest-only repayments for a while, the bank would almost certainly say no. Banks also classify the severity of hardship in individual cases according to their own rules. Circumstances such as maternity leave or redundancy must be assessed individually, rather than treated uniformly. To his knowledge, most banks allow investors to make interest-only repayments for up to five years, while owner-occupiers are usually allowed only two to three years.
Infometrics chief forecaster Gareth Kiernan said interest rates had risen to levels people buying homes in the first half of 2021 had never imagined. Borrowers refixing from rates of around 2.5% p.a. would therefore find their household budgets under unprecedented pressure. He expected more borrowers to start feeling the strain from the end of this year as they returned to their banks to refix. Although switching to interest-only repayments is one way people might try to cope with rising rates, he said the Reserve Bank would regard it as a “relatively risky” move and would not encourage banks to do so. Many borrowers might consider it in future, but banks would also be selective, reserving the option for the people and households who most needed help to get through. He also noted that even during last year's low-rate environment, banks were still stress-testing at rates of at least 6%, so repayment difficulties should affect only those facing financial emergencies. In theory, borrowers who maintain their usual employment income should be able to afford the increased repayments. Those facing additional repayment pressures would be at greater risk of being unable to pay.
Meanwhile, CoreLogic head of research Nick Goodall said many commercial banks were less willing than before to switch borrowers to interest-only repayments because they preferred to see debt reduced. Borrowers might likewise want to avoid interest-only repayments to pay less interest and reduce their loan balances as quickly as possible, particularly as changes to interest deductibility would have a significant effect over the next five years. The Reserve Bank's latest figures show a declining share of interest-only lending, although it is still occurring in some circumstances. His advice was that people falling into hardship was never a good thing, so if switching to interest-only repayments was their only option, some would choose it. However, he believed borrowers would also consider the risks. As house prices fell, homeowners could face greater risks, and a misstep could leave them in negative equity.
To explore this widely discussed issue in depth, YIJU once again spoke to three senior mortgage advisers from New Zealand's Huarong lending team.
Q: With the Reserve Bank making another sharp increase today as expected to the OCR, does this mean another wave of interest rate rises is about to begin?
Toby Shi：Today's sharp OCR increase of 50 basis points could lead to another rise in interest rates at New Zealand's commercial banks. Both the speed and scale of recent increases have been quite astonishing, leaving people anxious at the very mention of interest rates. Clients who bought property in the low-rate environment of the past year or two really do need to rework their household budgets.
Grace Huang：Interest rate increases are closely linked to many financial and global market factors. Past experience shows that an OCR increase directly affects bank interest rates because it is a major factor in banks' funding costs. Although recent price competition between banks has brought some small rate cuts, the overall upward trend in interest rates still follows changes in the OCR.
Charles Wu：In the short term, an OCR increase of 50 basis points will indeed put upward pressure on lending rates. However, with lending rates already relatively high, I remain cautious about whether they will rise substantially.
Q: If borrowers cannot afford rapidly rising mortgage repayments, is switching to interest only repayments and extending the loan term feasible? If so, what should borrowers bear in mind?
Toby Shi：Faced with rising interest rates, many homeowners are considering switching to interest-only repayments to ease the pressure of regular repayments. This requires an application to the bank for approval. Although many clients meet the criteria, such as applicants with good incomes, banks will still require many applicants to continue making principal-and-interest repayments as part of their own risk management. As lenders, banks want to start gradually recovering the principal they have lent, rather than waiting until the final few years. Clients should ask their bank manager about the application process or apply through a mortgage broker.
Grace Huang：Recent interest rate increases have squeezed many people's finances, placing borrowers under growing financial pressure. Switching to interest-only repayments can certainly ease some of the repayment burden, but who qualifies? Taking ANZ's policy as an example, the maximum interest-only period available ranges from 2 to 5 years, depending on whether the property is owner-occupied or an investment. The bank must approve the borrower's repayment capacity before allowing a switch to interest-only repayments. A substantial change in the borrower's finances and income gives the bank grounds to decline the application. Borrowers who have previously had and exhausted an interest-only term at the same bank cannot apply again.
Charles Wu：Switching to interest-only repayments and extending the loan term are feasible in the short term, but the bank will usually reassess the loan. With mortgage repayments rising rapidly, borrowers should focus on two things:
- Increase income: a. Hold on to your current job and, where circumstances allow, discuss a pay rise with your employer. b. Take a part-time weekend job. c. Rent out one or two rooms, for example.
- Reduce spending: a. Eat out less often, buy groceries and cook at home. b. Cut non-essential spending, such as purchases of luxury goods.
Even borrowers whose fixed terms have not yet expired should ask their mortgage advisers about current interest rates, budget ahead for their households and plan how to maintain stable income for their businesses.