Interest rates biting but mortgage arrears remain low

Despite the twin challenges of higher interest rates and inflation, New Zealand's banking system remains in sound shape, while mortgagees are generally coping, according to the latest Financial Stability Report from the Reserve Bank of New Zealand (RBNZ).

At the institutional level, the banking system is “well placed to handle potential external shocks and a downturn in the economy”, based on recent stress tests.

“Banks’ liquidity positions are strong and capital ratios are well progressed towards meeting the higher requirements being phased in by 2028. Asset quality is currently high, but banks are preparing for a likely deterioration over the medium term,” the RBNZ said.

At the household level, mortgagees have had to cope with significantly higher interest rates, including borrowers who have reverted from low fixed to higher floating rates.

“Around two-thirds of the mortgage debt that was fixed at very low interest rates during the early stage of the pandemic has now rolled over to higher interest rates, with this process expected to continue over the next year. The effective mortgage rate, which is an average rate paid across the stock of all mortgage lending, is expected to reach 6.4% by mid-2024, from its low point of 2.9% in late 2021,” the RBNZ said.

How households are coping with higher rates

Unsurprisingly, higher rates are placing an increased strain on indebted households’ budgets, with the average share of disposable income going to interest payments expected to rise from 9% in 2021 to around 18% by the middle of 2024. 

“While this would still be well below previous periods of financial stress, such as in the late 2000s, the adjustment to higher interest rates is likely to be felt more strongly by certain cohorts of borrowers,” the RBNZ said. 

“Measures of acute financial distress such as loan arrears have been steadily increasing over the past year but remain well below levels seen following the GFC. Mortgage borrowers have so far been able to adapt to higher repayments by cutting discretionary spending and have been supported by strong household income growth. Some borrowers have been able to lessen the impact of higher interest rates by extending the remaining term of their loan, if ahead of their original repayment schedule.”

The RBNZ said that while shorter-term mortgage interest rates had continued to climb, longer-term rates had generally stabilised over the past six months.

“Moreover, high inflation is also being reflected in asset prices, including housing, and household incomes. Compared to the median household disposable income, median house prices have fallen from a ratio of 11 times to around 9 times.”