Quarter of 2021 first-home buyers likely under mortgage stress, Reserve Bank says

An estimated quarter of first-time homebuyers purchasing in 2021 are under mortgage stress at today’s interest ratesby the Reserve Bank.

Reserve Bank mortgage stress analysis it is based on an interest rate of 5.5%. On Friday, the big four banks had one-year rates of 5.45% and two-year rates of 5.65% or more.

A spokesman said that meant that when borrowers who took out loans in 2021 came to refix, they would likely find that the income they had left after tax and mortgage payments would be reduced to a point where they would have to significantly reduce their spent.

If interest rates were to rise to 7%, which is what is approaching floating rates on home loans, the number of stressed first-time buyers would rise to just over 57%, and between about a quarter and a A third of the other 2021 owner-occupants and investors are also under stress.

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spokesman said most mortgage borrowers from 2021 stayed with the low interest rates available last yearand still hadn’t fixed it.

When these renovations occurred, Lender Stress Tests of Home Loan Applicants it was predicted to act as a safety net keeping recent buyers’ heads above water and houses out of forced sales.

“Stress testing” refers to the practice of banks verifying that home loan borrowers can repay loans at higher interest rates.

Reserve Bank Governor Adrian Orr referred to these tests at the August Monetary Policy Statement press conference, saying that based on the “oversight activity” of bank stress tests retailers, he was assured that interest rate increases would be “Survivable, but will mean for recent buyers to tighten their belts”.

But how the banks are testing their applicants, the formulas they use and what they consider affordable. For each borrower, it is largely an unknown quantity.

a mortgage broker called them a “black box”, Y the banks refused to give information about how they evaluated borrowers, often citing business sensitivity.

For the Reserve Bank, a borrower is assumed to be in service stress if increases in their repayments mean they have to cut their typical expenses.

The spokesman said banks assessed affordability as the ability to maintain “a minimum level of consumption,” sometimes called essential consumption or spending.

“Our definition of stress is less severe. Our definition is when a household cannot afford a modest level of spending that includes both essential expenses and some discretionary expenses.

Banks’ stress test of interest rates (called the service sensitivity ratio, or SSR) is well-known: most banks publish the information, and the Reserve Bank collects the data, publishing an average in its Financial Stability Report. biannual.

Most SSRs are about 2.5% above the one-year rate.

Currently the rates used by the three major mortgage lenders are 7.95% at ANZ, 8.15% at ASB and at Westpac, applications are tested at 2.5% above the going rate..

But the interest rate test itself is only half the equation: the other parts are how much of the borrower’s income is used for mortgage payments, and how much of the income is considered to be the loan. it becomes unaffordable.

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Since the changes in the Credit Agreements and Consumer Financing Law (CCCFA) that entered into force on December 1, Banks have been required to keep records of affordability inquiries and how borrowers were screened, and the Commerce Commission has the power to require them.

Commerce Commission credit general manager Louise Unger said there were currently no investigations or planned investigations into how banks have stress-tested home loan borrowers.

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The commission’s view was that the principles of responsible lending affordability were likely violated if a lender failed to take potential interest rate increases into account when evaluating a mortgage loan.

The key test of affordability in the CCCFA regulations states that a lender must be satisfied on reasonable grounds that the borrower was likely to make payments without substantial hardship, meaning that the borrower’s income must exceed probable relevant expenses. .

This included ensuring that there was a reasonable surplus in the borrower’s income, and estimates of income versus expense included reasonable allowances if income had been overstated or expenses had been understated.

There is also a Responsible Lending Code issued by the Ministry of Business, Innovation and Employment (MBIE) that has a guide for lenders on how they must comply with the principles of responsible lending, but these are recommendations, rather than requirements.

It states that lenders “should consider applying buffers” to the loan’s interest rate, to mitigate the risk that potential interest rate increases will negatively affect the borrower’s ability to repay.

The Reserve Bank is currently working on improving its mortgage stress model and will provide an update in its next Financial Stability Report (FSR), due on November 2.

The spokesman said that people who bought a property before 2021 were more resistant to rising interest rates because they had had more time to pay off their mortgage.

“In addition, many former borrowers have experienced higher mortgage rates in the past. Borrowers in 2022 have been tested with higher mortgage rates.”

ANZ senior economist Miles Workman said it was very difficult to gauge when the official cash rate (OCR) had been high enough to combat inflation.

MONIQUE FORD/Things

ANZ senior economist Miles Workman said it was very difficult to gauge when the official cash rate (OCR) had been high enough to combat inflation.

ANZ Senior Economist Miles Workman said there were a lot of “unobservable variables” when trying to estimate how many households were under stress.

They included the rate at which household incomes were growing (some data suggested they were actually keeping pace with interest rate increases) and whether borrowers paid higher repayments during times of record interest, which would ease a little tail.

He also said that if a household were a net saver, higher interest rates would actually help finances as they would receive higher returns on their savings.

Households with a high debt-to-income ratio would be the hardest hit by rate hikes, he said.

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