Over the past two weeks, several banks have raised the interest rate at which home loan borrowers are stress tested, signaling that interest rates are likely to hit a higher than expected high.
Even for those who work closely with banks, the details of how the tests are carried out and what they entail are a mystery, and the government recently concluded an investigation into how banks were conducting their lending.
Glen McLeod, director of Edge Mortgages, described the stress-testing process as a “black box”, where the finer details of the process and the standard for assessing borrowers were not fully known.
Responsible lending rules that affect mortgage valuations changed in December after changes to the Consumer Credit Agreement and Credit Act (CCCFA) came into effect. This change precipitated a sharp drop in mortgages granted by banks.
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The cut was so sharp that Trade and Consumer Affairs Minister David Clark accused banks of failing to comply with responsible lending laws before December, summoned bank chief executives to face-to-face meetings face to explain and ordered an investigation to determine whether banks had overreacted to new lending laws.
The government has since announced a relaxation of some of the new CCCFA rules when applied to home loans, and Clark has remained tight-lipped on the outcome of the investigation.
“I have received the final report from officials and the Board of Financial Regulators on the initial implementation of amendments to the Credit Agreements and Consumer Credit Act,” he said.
Decisions on the government’s next steps will be made by June 30, he said.
Bank stress tests at different rates
Banks stress test home loan borrowers at different rates. For ASB, the serviceability rate now stands at 7.35%, while Kiwibank increased its stress test rate to 7% on Monday.
ANZ, the country’s largest lender, is now stress tested at 7.15%.
Westpac chief executive Catherine McGrath said the bank’s stress test was 2.5% above the rate borrowers were asking.
McLeod said the test rate figure was only half of the valuation and banks had other criteria that needed to be met before giving a loan.
The differences in screening rates were likely due to the different formulas used by each bank.
He said mortgage brokers spent a lot of time jumping between different bank calculators to see which would be the best option for clients. The reason for some results was not always obvious.
He recently assessed a small family, entering their monthly living expenses at just over $3,000 after reviewing their accounts, but the calculator bumped the figure up to over $4,400.
“I don’t know where the extra expense is coming from,” McLeod said.
“We never see that context. We only see the beginning of the operation, we don’t see how they calculate it within the limits of their affordability calculators. »
None of the banks approached were willing to share details of their rating processes, and several have not publicly disclosed their test rates.
History of not intervening on stress testing rates
Last November, the Reserve Bank asked for comments on the creation of a floor on test interest rates – a tool that is used in other countries.
In Australia, since October 2021, banks are required to stress test at 3 percentage points above the lending rate, and in Norway it was 5 percentage points above the interest rate in force, according to the Reserve Bank report.
In New Zealand, banks set their own test interest rates, and the Reserve Bank has considered a few alternatives, including a hard floor, such as banks must test at a rate of 7%, or as a margin or a buffer above current lending rates.
After consultation with banks, industry and community groups, the Reserve Bank decided not to pursue any type of floor, instead focusing on designing a framework to implement debt-to-income restrictions.
The Reserve Bank also considered a floor for stress test rates in 2017, when it also looked at debt-to-income ratios (DTIs).
But both were dropped when house price inflation slowed. Two years later, New Zealand has seen the fastest house price increases on record.
The Reserve Bank’s head of financial system analysis Chris McDonald has refuted the idea that the bank has become reactionary, despite previously investigating regulation only to abandon it when the market s is cooled.
The central bank has had loan-to-value ratio (LVR) requirements in place since 2013, and it was preparing a DTI tool that could be rolled out quickly if needed, McDonald said.
McDonald said banks’ debt service ratings must meet responsible lending requirements set out in the CCCFA, which provided limits within which the ratings must fall.
“It involves ensuring there is a sufficient income buffer after non-discretionary spending so that borrowers can repay debt even if things change over time,” he said.
The Reserve Bank’s May Financial Stability Report noted that the risk of debt-service stress or negative equity was low for most mortgage borrowers.
However, he noted that recent borrowers who have taken out large mortgages relative to their income would incur significant debt-service costs if mortgage rates were to exceed these test rates.