Banks’ test interest rates remain high, despite looming official cash rate cuts

Reserve Bank's debt-to-income restrictions are likely to be the hurdle prospective borrowers will need to tackle once interest rates fall. Photo / Alex Burton

ANALYSIS

Mortgage rates have been falling throughout the year, but the hurdles aspiring borrowers need to clear to secure bank loans remain restrictive.

One-year mortgage rates have fallen to around 6.33%, according to interest.co.nz, having peaked at 7.35% in January.

While a rate starting with a six feels much more palatable than one starting with a seven, banks told the Herald they’re still testing applicants at rates shy of 9%.

ANZ, BNZ and Kiwibank are requiring mortgage applicants to prove they can afford to service debt at an interest rate of 8.5%. Westpac is testing at 8.65% and ASB at 8.7%.

While the housing market is recovering, it’s still weak. Demand for new mortgages in August was just above August 2022 and 2023 levels, but well down from August 2020 and 2021.

In July last year, when one-year mortgage rates sat at around 7%, banks used slightly slimmer buffers than they are now, testing applicants at between 8.75% and 9.1%.

When mortgage rates were at rock bottom during the pandemic, banks kept their test rates up at around 6%.

Some borrowers would’ve felt the pinch when rates subsequently rose above 6%, but banks’ conservative approach likely prevented some wannabe borrowers from running into trouble.

Loan Market mortgage adviser Bruce Patten expected test rates to fall, as the Reserve Bank (RBNZ) continues to lower the official cash rate (OCR). He hoped test rates would get below 8% by Christmas.

All eyes are on whether the RBNZ will cut the OCR by 25 or 50 basis points at its next review on Wednesday.

The RBNZ’s aggressive interest rate hikes have tamed inflation. The question now is, how quickly should it take the OCR back to a neutral level?

The RBNZ will be mindful of not going too fast and reigniting rapid price rises. On the other hand, it won’t want restrictive policy to damage the economy, create financial instability, and see inflation fall too much.

The RBNZ cut the OCR for the first time in this easing cycle in mid-August, lowering the rate by 25 basis points to 5.25%. It suggested the OCR might fall to around 3.8% by the end of next year.

Patten believed the introduction of debt-to-income (DTI) restrictions would prevent the housing market from taking off, should interest rates really fall.

As of July, the RBNZ has been restricting the amount banks can lend to those seeking large mortgages relative to their incomes.

The restrictions haven’t had any bite yet because high interest rates are making borrowing a lot unaffordable.

For example, someone with an income of $100,000 a year probably couldn’t afford to take out a $650,000 30-year mortgage at an interest rate of 6.5%, because their weekly repayments would be $950.

If mortgage rates fell to, say, 4.5%, borrowing this sum would look more doable, as their weekly repayments would be around $760.

At this point, the RBNZ’s DTI restrictions would likely be the handbrake that prevented the prospective borrower from getting a loan, as the rules cap the amount banks can lend to owner-occupiers seeking mortgages worth more than six times their annual incomes, and investors seeking mortgages worth more than seven times their annual incomes.

Patten recognised the OCR would need to be cut quite a bit more to reach the point where DTI rules had an effect. But he believed some people would be hamstrung.

RBNZ figures show interest rates were super low during the peak of the pandemic – as much as 45% of new bank lending was to investors who took out debt worth more than seven times their annual incomes. By July this year, this portion had fallen to 5%.

Under the RBNZ’s rules, no more than 20% of a bank’s new lending to investors can go to those seeking debt worth more than seven times their incomes.

Banks are required to put all the debt a prospective borrower has into the equation, not just the debt they’re seeking to buy a particular property.

Similarly, they can consider all the borrower’s income, not just their salary/wages.

Despite people borrowing up a storm in 2020 and 2021, when no DTI restrictions were in place and banks were testing people at interest rates below that which they rose to, people have generally managed to meet their repayment obligations.

In August, 0.6% of the $358 billion of mortgages issued by banks was considered non-performing.

While this percentage has shot up in recent years (it was only 0.2% in August 2022), it’s well down from the 1.2% levels hit after the 2008 Global Financial Crisis, when banks were more lightly regulated than they are now.

Jenee Tibshraeny is the Herald’s Wellington business editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.