In the last two weeks, multiple banks have jacked up the interest rate home loan borrowers are stress tested at, signalling an expectation interest rates will reach a higher peak than previously predicted.
Even for those working closely with the banks, specifics of how the testing is done and what it involved is a mystery, and the Government recently concluded an inquiry 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 by which borrowers were assessed were not fully known.
The responsible lending rules that affect mortgage assessments changed in December after changes to the Credit Contract and Consumer Finance Act (CCCFA) came into forced. The change precipitated a sharp drop in home loan lending by banks.
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The reduction was so sharp, Commerce and Consumer Affairs Minister David Clark accused banks of failing to abide by responsible lending laws before December, summoned bank chief executives to face-to-face meetings to explain, and ordered an inquiry into whether banks have overreacted to new lending laws.
The Government has since announced a relaxation of some of the new CCCFA rules when applied to home loan lending, and Clark remained tight-lipped on the result of the inquiry.
”I’ve received the final report from officials and the Council of Financial Regulators on the initial implementation of changes to the Credit Contracts and Consumer Finance Act,” he said.
Decisions on the Government’s next steps would be made by June 30, he said.
Banks stress testing at different rates
Banks stress test home loan borrowers at different rates. For ASB, the serviceability rate now sits at 7.35%, while Kiwibank increased its stress testing rate to 7% on Monday.
ANZ, the country’s largest lender, is now stress testing at 7.15%.
Westpac chief executive Catherine McGrath said the bank stress tested 2.5% percentage points above the rate borrowers were applying for.
McLeod said test rate figure was only half of the assessment, and banks had other criteria that had to be satisfied before granting a loan.
The differences in testing rate were probably due to the different formulas each bank used.
He said a lot of time was spent by mortgage brokers jumping between different bank calculators to see which would be the best option for clients. The reason for some results were not always obvious.
He recently assessed a small family, inputting their monthly living expenses at just over $3000 after looking over their accounts, but the calculator increased the figure to over $4400.
“I don’t know where the added expense comes from,” McLeod said.
“We never get to see that background. We only get to see the front end of the operation, we don’t see how they calculate it in the confines of their affordability calculators.”
None of the banks approached were willing to share details of their assessment processes, and multiple did not disclose their test rates publicly.
History of not intervening on stress testing rates
Last November the Reserve Bank sought feedback on creating a floor on the test interest rates – a tool which is used in other countries.
In Australia, since October 2021, banks have been required to stress test at 3 percentage points above the rate lent out at, and in Norway it was 5 percentage points above the prevailing interest rate, according to the Reserve Bank’s report.
In New Zealand, banks set their own test interest rates, and the Reserve Bank considered a couple of alternatives, including as hard floor, such as banks must test at a rate of 7%, or as a margin or buffer above current lending rates.
After consultation with banks, industry and community groups the Reserve Bank decided not to pursue any kind of floor, instead focusing on designing a framework to implement debt-to-income restrictions.
The Reserve Bank also considered a floor for stress testing rates in 2017, when it also looked at debt to income ratios (DTIs).
But both were scrapped as house price inflation slowed. Two years later, New Zealand experienced the fastest house price increases on record.
Reserve Bank financial system analysis manager Chris McDonald refuted the idea the bank had become reactionary, despite previously investigating the regulation only to drop it when the market cooled.
The central bank has had loan to value ratio (LVRs) requirements in place , since 2013, and it was preparing DTIs tool that could be put in place quickly if required, McDonald said.
McDonald said banks’ debt serviceability assessments needed to meet the responsible lending requirements set out under the CCCFA, which provided boundaries that assessments had to fit within.
“This includes ensuring there is a sufficient income buffer after non-discretionary expenses so that borrowers are able to afford the debt even if things change over time,” he said.
The Reserve Bank’s May Financial Stability Report noted the risk of debt servicing stress, or negative equity was low for most mortgage borrowers.
However, it noted recent borrowers who took on large mortgages relative to their incomes would incur significant debt servicing costs if mortgage rates were to rise above those test rates.