Former Economics Editor of the NZ Herald

Brian Fallow: How much mortgage is too much?

Low interest rates make even big home loans affordable - at least for now. File house photo / Doug Sherring
Low interest rates make even big home loans affordable - at least for now. File house photo / Doug Sherring

New Zealand households increased their mortgage debt by a net $19 billion or 9.2 per cent in the year ended August.

It was the fastest annual growth for more than eight years. And it almost certainly outstripped the combined effect of population and income growth, even if they are running at cyclical highs.

So the ratio of household debt to income will have risen to a new record high.

How worried should we be about that? Not too much, according to the Treasury.

But Bank of New Zealand economist Craig Ebert takes a less sanguine view.

You would expect it to be the other way around - the officials' brows furrowed while a bank economist smiles reassuringly.

Illustration by Anna Crichton.
Illustration by Anna Crichton.

The Treasury says it is not clear what levels of debt are too high. Officials take comfort from the fact that the accumulation of debt "to date has not been the result of sustained dis-saving", that is, households' collectively spending more than their incomes.

The weasel word there is "sustained". Household saving turned positive in 2010, in the wake of the global financial crisis recession. That followed nine straight years of a negative saving rate.

But the saving rate turned negative again last year and the Reserve Bank expects it to remain negative this year and next year, though admittedly not to the degree seen during the mid-2000s boom.

Household deposits in the year to August grew by 7.8 per cent, the slowest rate for two years and less than the 9.2 per cent rise in mortgage debt. At $157b, deposits cover just 70 per cent of housing debt.

It is a bit ironic that while some people panic about foreign purchases of New Zealand property - tenants in our own country! - we happily rely on foreign savers to supply 28c in every dollar we borrow from our banks.

While household debt levels have been rising and debt-to-income ratios have become more stretched, low interest rates have meant that the share of disposable incomes consumed by mortgage interest costs has fallen to around 9 per cent, from a peak of 14 per cent in 2008.

The Reserve Bank is expected to cut the official cash rate further.

And with the mortgage rates that banks offer to new borrowers being lower than the average interest rate now being paid, debt servicing rates are likely to decline over the year ahead, the Treasury says.

That rather glosses over the relentless rise in house prices, which continues, and which underpins the accelerating increase in debt levels.

So long as New Zealand banks have to compete for funding offshore, and face fluctuations in the risk premium demanded by those who lend to us, we remain at the mercy of global events.

Quotable Value reports that last month the average house price nationwide was 14.3 per cent higher than in September last year.

Annual increases of more than 20 per cent were recorded in Tauranga, Hamilton, Rotorua, Whangarei and Wellington, and over 30 per cent in and around Queenstown.

The BNZ's Ebert says a lot of factors - record immigration, land supply constraints, a lagged construction response and high and rising building costs - are all relevant to the "eye-watering" prices people are paying for property.

But the "inflammatory" role of very low interest rates has to be appreciated as well, he says.

As a matter of simple arithmetic, the lower interest rates go, the greater the effect on affordability that any given basis points change in rates will have.

If mortgage rates fall from 9 to 8 per cent, then affordability rises by 12.5 per cent, but a fall from 5 to 4 per cent increases the borrower's purchasing power, all else being equal, by 25 per cent.

That works both ways: households' sensitivity to future interest rate rises will be greater.

Monetary policy will need a more delicate touch, but interest rates have always been a blunt instrument.

How high house prices are, and how low mortgage rates are, stand out like the proverbial, Ebert says, even in an economy that is otherwise looking normal.

"So even if some of the broader demand forces in the housing market abate, and supply factors respond, people will still be able to 'afford' to pay very high prices for homes while interest rates stay this low," he says.

"However, to the extent interest rates go back up ...," he trails off ominously.

To be fair, the Treasury officials acknowledge that the robust state of the household balance sheet, in aggregate, masks the fact that some households are up to their nostrils in debt.

Representative new buyers in Auckland - those buying a house of average value ($1 million!) on an average income, with a 20 per cent deposit - are already paying 46 per cent of income, even with current low interest rates. Their debt servicing rates would pass previous peaks if mortgage rates were to return to their 10-year average of 6.7 per cent.

Fear not. Domestically driven increases in interest rates would depend on inflation pressures rising as domestic activity grows, the Treasury argues, and that would be likely to be accompanied by more jobs and higher incomes.

But note the caveat: "domestically driven". Interest rates could rise for reasons unrelated to the New Zealand economy, like an eventual turn in the global interest rate cycle. The US Federal Reserve is expected to raise its equivalent of the official cash rate before the year is out.

So long as New Zealand banks have to compete for funding offshore, and face fluctuations in the risk premium demanded by those who lend to us, we remain at the mercy of global events.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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