Households can cope with a rise in home loan rates, but new buyers will feel the squeeze

Thursday, 15 July 2021

Households’ spending power is going to be squeezed as inflation and home loan rates edge up.

EXPLAINER: Home loan rates could rise by as much as 1.5 percentage points, but most households can cope, says economist Gareth Kiernan.

The rises will suck some spending power out of households in six to 18 months time, but home loan rates will still be lower than before the Covid-19 pandemic struck, says Kiernan, chief forecaster at Infometrics.

But most households, even recent buyers with large home loans, should be OK, he says.

On Wednesday, ASB led the way edging up home loan rates, as bank economists forecast that with the economy running hot, the Reserve Bank's official cash rate would start rising next month.

“Home loan rates could be going up 1.5 percentage points [by the end of 2023], but you would still be talking about a range under 4 per cent,” Kiernan says.

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“Before Covid that was pretty much unprecedented. It would still be affordable, even for people who bought in the last year of so,” Kiernan says.

“Yes, they would be highly leveraged, but the banks have been putting on some significantly higher test rates around their stress-testing.”

Infometrics is picking the official cash rate to rise to 1.5 per cent by the end of 2023 from the current 0.25 per cent.

Infometrics chief forecaster Gareth Kiernan says banks calculate loan affordability for potential borrowers using high ‘test’ rates, so recent borrowers should be able to cope with higher home loan rates.

What will this do to household finances?

It will squeeze household spending, Kiernan says, but it won’t crash house prices.

“Mortgage rate increases of this magnitude will not be enough to cause house price falls, even with residential consent numbers running at record high levels.”

If that forecast turns out to be true, there will be no worries about people finding their home equity eroding, or heading into negative territory.

In the first five months of the year, a little under $1 in every $10 in new home loans from the banks was to homeowners with a deposit of less than 20 per cent, Reserve Bank data shows.

The test rates Kiernan talks about are the interest rates the banks use when calculating whether would-be borrowers can afford the home loan they are asking for.

Instead of calculating affordability based on their current income and anticipated post home-loan expenses using current home loan rates, banks typically do the calculation as if home loan rates were 6 to 7 per cent.

This should mean borrowers can cope with a near doubling of the home loan rate before they start to struggle.

Bigger mortgages mean more pain

For first home buyers, and people who have big home loans, it could be painful.

Rises in a borrower’s overall borrowing rate by 1 percentage point, from 3 per cent to 4 per cent, would mean addition interest costs of $1000 a year for every $100,000 they owed to the bank.

Reserve Bank data shows that the in the first three months of the year, $4.2 billion of home loans were made to borrowers with loans of five or more times their incomes.

Global supply chains have been slowed by the Covid-19 pandemic, and the costs of moving goods around the world have risen.

Those on an average gross household income of just under $110,000 would owe $550,000 or more, so a rise of 1 to1.5 percentage points on their borrowing costs implies an extra home loan interest cost of $5500 to $9900.

Other living costs rising

Kiernan says employment remains strong, so most households will not be worrying about their job prospects.

Financial adviser Hannah McQueen says many households can find savings in their spending to help cope with higher interest rates.

But home loan rate rises will not be the only cost of living increases households face.

“Inflation could climb above 3 per cent this year, with mounting questions about the Reserve Bank’s assumption that this spike will be temporary,” Kiernan says.

This was caused by pressures including a tripling of container costs for international shipping, higher commodity prices because of recovering global demand, rising prices for oil and electricity, and higher wages needed to attract and retain staff in an increasingly tight labour market, he says.

Shaving $1000 off spending

Financial adviser Hannah McQueen says many households can find savings on their spending.

But it could be bad news for the hospitality sector.

“The easiest place to find any savings is food and drink,” she says.

Eating at home, instead of eating out can save households money, and that can add up fast to big savings.

“The next place to find it is in your mortgage structure and insurances,” she says.

This involved people getting advice, and seeking better deals than they currently had.

Then find multiple small cutbacks on household bills, but this takes a bit of time to achieve, she says.

McQueen also finds people can trim their “discretionary” day-to-day spending, while not ruing their sense of happiness in life.