There are risks attached to borrowing against inflated home prices, warns Diana Clement.

Auckland home owners are feeling wealthy as they see their homes skyrocket in price. When they do, it often leads to thoughts of borrowing and spending.

The changing face of debt in New Zealand means it has become common to borrow against the home for everything from holidays to renovations. A mortgage top-up is an easy fix to make credit card bills go away or buy a flash new car.

Top-ups give homeowners all the trappings of wealth and the ability to live as they believe they deserve, but it can be a disastrous mistake. Household balance sheets have become increasingly leveraged over the past couple of decades.

Household debt as a percentage of nominal disposable income has risen from 83.3 per cent in Q4 1996, to 162.3 per cent in Q4, 2015 according to Reserve Bank of New Zealand (RBNZ) figures.


The ANZ says it handles more applications for top-ups than it does for new mortgages every year. Those top-ups aren't just to cover flash-cash spending, the ANZ points out. They are also used for buying rental properties. Whatever the reason, top-ups come with risks.

Risk one: Longevity risk. The risk with mortgage top-ups is that homeowners won't have paid off the mortgage when they reach retirement and won't be able to afford the monthly repayments on New Zealand Super alone.

In that situation the options can be grim: downgrade to a lesser home; pay off the mortgage with your KiwiSaver, leaving no money for the boat, bach or round-the-world trip, or simply living off those savings; or work until you drop.

Statistics New Zealand Census data regarding 65-year-olds still paying a mortgage is interesting, although not entirely black and white. Of like-for-like cohorts of 65-year-olds who could be identified form the data, 3.5 per cent still had a mortgage in 2006. By 2013 that number had jumped to 6.11 per cent, which could be a worrying trend.

Risk two: Payment shock. When mortgage rates rise (as inevitably they do at times in the economic cycle) Kiwis' monthly mortgage payments will rise.

All floating mortgage rates carry a risk of payment shock and so do fixed rate mortgages when the fixed period finishes.

Borrowers who have entered the market in the past five years are especially at risk because they have done so on the basis of low-entry costs and may not fully understand the interest rate cycle.

One way to counter payment shock is to do the opposite of topping up. That's to overpay the mortgage to build in a buffer.

Or don't borrow against the mortgage and wait until you have cash to pay for whatever it is you want to buy.

Risk three: Income shock. Kiwis assume their current income will either stay the same or increase, not drop dramatically. Yet New Zealanders live in a world where two billion jobs will disappear by 2030.

Add to that the risk of relationship breakdown, adverse health events or disablement of the main income earner. Any of these can compromise homeowners' ability to pay the mortgage. If they don't pay, they may be forced to sell.

The RBNZ warned of this in its May 2016 Stability Report, pointing out that a relatively small increase in interest rates could place pressure on some borrowers, especially those with high debt-to-income ratios.

The RBNZ noted that housing credit has continued to grow rapidly with growth of 8 per cent in the year to March, the highest rate since 2008.

"If interest rates returned to the 10-year average of 6.7 per cent, debt servicing ratios for the representative new buyer in Auckland would significantly exceed the pre-GFC peak."

Risk four: Equity risks. Upping the mortgage raises the loan to value ratio, meaning the homeowner has less equity to play with should home values fall, a concept that few Kiwis are willing to accept as a possibility.

Nor have many had any experience of negative equity or home loans being called in, which could happen if prices fall and banks no longer meet minimum capital ratios set by the RBNZ.

Borrowers who have upped the LVR to cover consumer spending are more likely to have their heads on the block of a forced sale than those that are diligently paying their loans down.