As mortgage rates increase, the test rates used by banks to assess whether mortgage applicants can repay their debt, if conditions change in the future, also increase.
New Zealand’s largest bank, ANZ, told interest.co.nz that those applying for mortgages must currently be able to convince the bank that they would be able to repay their debt at a rate of interest of 6.7%.
Meanwhile, ASB said it is testing applicants using a rate of 6.85%.
Both banks’ standard 1-5 year fixed mortgage rates range from 4.49% to 6.45%.
The SBA said it was reviewing its test rate in response to recent interest rate changes following the latest increase in the official exchange rate (OCR).
ANZ made a more general comment that its test rate is “regularly reviewed in light of the changing interest rate environment”.
The other big banks – BNZ, Kiwibank and Westpac – would not share their test rates, but also commented on how they are regularly reviewed.
Room for testing rates to increase?
Going forward, test rates are expected to increase, along with OCR and mortgage rates.
If banks’ test rates are calculated by adding similar margins to the OCR, or average one-year mortgage rate, as they have done in the past, their test rates should exceed 7%.
Reserve Bank (RBNZ) data shows that the buffer between the average 1-year mortgage rate (which is currently 4.1%) and the average bank test rate stood at 3-4 percentage points between 2017 and 2021.
Similarly, the buffer between OCR (which is currently 1.5%) and test rate hovered around 6 percentage points between 2018 and 2021.
The RBNZ expects the OCR to peak at 3.4% in this tightening cycle. He could not tell interest.co.nz what the average testing rate was in 2015, when OCR was last so high.
Someone wanting to borrow $500,000 over 30 years would have to convince their bank that they could make repayments of $806 a week if tested at 7.5%.
That’s $62 more per week than if ANZ’s current test rate were used, and $249 more per week than someone would pay if it were set at 4.1%.
RBNZ could set test rate
The RBNZ is considering setting a minimum test mortgage rate for banks. He consulted on this between November and February and will likely have more to say about it when he releases his financial stability report on May 4.
His proposal was to impose a minimum test rate to “address short-term financial stability risks” while he works with banks to establish a debt-income restriction (DTI) regime.
The RBNZ did not specify where it would set the test rate, but modeled the impacts of it at 7% and 8%.
The RBNZ said it could introduce a minimum testing rate between April and June, as an interim measure, before DTI restrictions are implemented by the end of the year.
The RBNZ said it was “unlikely” to impose a minimum testing rate and DTI restrictions simultaneously.
The DTI restrictions would limit the amount of new mortgages that could be issued to low-income borrowers relative to the amount of debt they seek.
The RBNZ noted that there were a number of approaches it could take to set a minimum test mortgage rate.
Its Australian counterpart requires banks to test applicants at a rate 3 percentage points higher than the rate of the loan product they want.
The RBNZ said its preference was to add a fixed buffer to a benchmark rate. While he noted that OCR is closely tied to mortgage rates, he said a longer-term rate like a 5- or 10-year swap rate might better reflect long-term trends in mortgage rates. interest. He said he could review the testing rate quarterly.
The RBNZ’s preference was to ensure the test rate was stable over time, moved automatically and was the same for all mortgage applicants – investors, existing homeowners and first-time homebuyers.
He acknowledged that the policy would hit first-time home buyers particularly hard, hence why he suggested that a minimum test rate be used only as an interim measure before the DTI restrictions are implemented.
The RBNZ has long wanted to be able to impose restrictions on debt servicing. Finance Minister Grant Robertson gave him the option to do so in 2021 as he came under pressure from soaring property prices.
The housing market and interest rate cycle have since reversed. In any case, the lending restrictions imposed by the RBNZ should support the stability of the financial system as a whole, rather than specifically targeting house prices.
See the mortgage calculator from interest.co.nz hereand a table comparing mortgage rates between banks here.