Interest expected to eat up 22pc of mortgage holders’ disposable incomes

Reserve Bank Governor Adrian Orr has said some people who took out high-leverage loans will be facing very high interest-servicing costs. Photo / Mike Scott

ANALYSIS:

The Reserve Bank has released projections that illustrate how much more pressure mortgage holders are likely to come under over the next year.

The central bank expects the average household with a mortgage to spend 22 per cent of their disposable income on interest payments by the end of the year.

This would be a decent rise from the end of last year, when the average household with a mortgage spent 14.5 per cent of their disposable income on interest payments.

Looking at how this ratio has tracked since the year 2000, 22 per cent would be above the average (17.4 per cent), but below the peak (26.9 per cent) experienced during the Global Financial Crisis in 2008.

While the rise in interest costs will be particularly concerning for recent first-home buyers with large mortgages, it follows a period of exceptionally low debt servicing costs.

The interest costs to disposable income ratio bottomed out at 9.5 per cent in September 2021 and remained below 12 per cent for more than two years around this time.

The rapid pace at which this rate is now rising is unsurprising, given the Reserve Bank has lifted the official cash rate (OCR) by 450 basis points since October 2021, and is planning to lift it by another 75 points, to 5.5 per cent, by the middle of the year.

The adverse weather events add an extra layer of uncertainty to the bank’s projections.

Nonetheless, the point its debt servicing to disposable income ratio projection highlights is that it takes time for OCR changes to take effect across the economy.

Mortgage holders only experience a higher OCR when they come to refix their mortgages.

As at December, half of the country’s mortgage debt was due for refixing within a year. So, many households are yet to come off the ultra-low rates of the Covid era.

Reserve Bank assistant governor Karen Silk explained this dynamic to Parliament’s Finance and Expenditure Committee on Thursday morning, when representatives from the Bank presented their latest Monetary Policy Statement.

When quizzed by National MP Simon Watts on the impact the rising OCR will have on mortgage holders, Silk noted the projected 22 per cent debt servicing to disposable income ratio was based on the assumption the average interest rate paid by mortgage holders would reach around 6.5 per cent by the end of the year.

As at December 2022, the average rate (fixed and floating) being paid was only 4.35 per cent.

In presenting these numbers, Silk made an error. She said the debt servicing to disposable income ratio was around 9 per cent in December 2022. This suggested an alarmingly fast rise to the projected 22 per cent by the end of this year.

When the Herald asked the Reserve Bank for the raw data, it turned out the ratio was actually 14.5 per cent in December.

Governor Adrian Orr told the committee the Reserve Bank’s focus had been on constraining the portion of high loan-to-value ratio (LVR) mortgage lending, or lending to borrowers with small deposits compared to debt. The data supports this comment.

Orr noted that on aggregate, balance sheets look good, “but without doubt, people who took out high-leverage loans in the 2021 period will be facing very high interest-servicing costs”.

What about renters?

They aren’t directly exposed to OCR hikes. But, the latest available StatsNZ data for the year to June 2021 shows 30 per cent spent more than 40 per cent of their disposable incomes on rent.

While interest rates were very low at this time, renters typically spent much more of their disposable incomes on housing costs than homeowners.