Welcome to our First Home Buyers Questions and Answers session.
Have you ever been to a seminar hoping for lots of useful information and walked away not knowing anything new? What a waste of time! Our Q&A session means you get answers to all the questions you have.
Our Panel includes:
- Rupert Gough – CEO of The Mortgage Lab and author of The Successful First Home Buyer
- Mat Page – CEO of Financial Design Group
- Ann Cochrane – Legal Executive for Simpson Western
- Cynthia Klenner – Harcourts Real Estate Agent – Glenfield
There will be no sales talk; nothing to buy; nothing to sign up to on the night. This is an information night so you can get all your questions answered.
Some topics we’ll most likely cover:
- KiwiBuild – what is it?
- HomeStart Grant and KiwiSaver basics
- What can you afford? How can you prepare for getting a mortgage?
- When do you get your Solicitor involved?How does the auction process work?
- How does purchasing work if you are borrowing over 80%?
Feel free to come with as many questions as you like. You should leave the session comfortable to move forward with the house buying process.
Doors open at 6pm and we will get questions started at 6:15pm. Parking is available in all Financial Design carparks outside. Come along early to grab some nibbles.
In recent years, the Reserve Bank of New Zealand has implemented a host of rules on the banks, particularly around mortgages. These rules have several purposes.
Some of them, like the LVR restrictions, are to stop the bubble mania of 2008 from happening again. The days of lending 100% (or more) on a property are gone and not returning any time soon.
Some of the new rules, like the Responsible Lending Code, should just always have been there. They require a lender to be able to hand-on-heart say that they were acting responsibly in granting a loan to the client. Banks are calculating a mortgage at 7.5% to allow for future interest rate rises. They also assume a 25% vacancy on rental properties which allows for some vacancies and other costs like repairs and maintenance.
These changes most often come up when a mortgage application is in, what I like to call, the “grey zone”. The clients is just on the edge of what the bank are comfortable with. Some examples of these grey zone applications are:
- bad credit history (even if it has been paid)
- >80% LVR borrowing
- significant reliance on rental income or government benefits for income
- self-managed builds
At first glance, none of these criteria are dealbreakers but the banks can only take on a certain number of these loans. They also don’t want to be known for taking on grey zone loans. If that happens, they end up holding a majority of those loans in the country which is obviously not preferred.
How do the banks decide who to give “grey zone” lending to?
Ask any Mortgage Adviser at the moment how to get a difficult application through the banks, they will answer the same way. A bank is more willing to lend to an existing customer than bring on a new customer. They have a lot more information on an existing customer and they are much more able to make informed decisions.
I have accounts with lots of banks. What constitutes an existing bank customer?
Banks count themselves as “your main bank” if your salary goes into one of their accounts. I know most of you have just seen a workaround but unfortunately this needs to have been happening for at least 3 months (sometimes 6 months). Don’t think you can change your salary payment tonight and be an existing client tomorrow.
Couples should use separate banks
It’s therefore a good strategy to have couples, who are looking to buy in the future, put their salary into different banks. You can still have a joint account but my suggestion is that you put your salaries into completely different banks and then transfer the money into the one account. Maybe put your personal spending through the different banks to really show that you are an existing customer.
With this strategy, you’ve now got 2 banks who think of you as an existing customer and are likely to be a little more lenient on you if you have to push the limits of their lending policy. A Mortgage Adviser will still be able to tell you which bank is better to approach first. Either way, with this strategy, you’ve doubled your odds of a successful outcome.
What is the OCR?
The OCR is an interest rate set by the Reserve Bank of New Zealand which defines the wholesale price of borrowed money. This directly affects the commercial banks, determining the rates they offer their customers. So it affects the rates banks charge for borrowing (mortgages, loans, credit cards) and what they will pay customers for saving (term deposits, savings accounts). The Reserve Bank reviews the OCR eight times a year. Monetary Policy Statements are issued with the OCR on four of those occasions. Unscheduled adjustments to the OCR may occur at other times in response to unexpected or sudden developments, but to date this has occurred only once, following the 11 September 2001 attacks on the World Trade Centre in New York.
What the OCR does
The OCR influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. An OCR is a fairly conventional tool by international standards. In the past, the Reserve Bank used a variety of tools to influence inflation, including influencing the supply of money and signalling desired monetary conditions to the financial markets. Such mechanisms were more indirect, more difficult to understand, and less conventional.
How the OCR works
Most registered banks hold settlement accounts at the Reserve Bank, which are used to settle obligations with each other at the end of the day. For example, if you write out a cheque or make an EFTPOS payment, the money is paid by your bank to the bank of the recipient. Many hundreds of thousands of such transactions are made every day. The Bank pays interest on settlement account balances, and charges interest on overnight borrowing, at rates related to the OCR. These rates are reviewed from time to time, as is the OCR. The most crucial part of the system is the fact that the Reserve Bank sets no limit on the amount of cash it will borrow or lend at rates related to the OCR.
The graph shows that the path of 90–day bank bill rates closely follows the OCR.
As a result, market interest rates are generally held around the Reserve Bank’s OCR level. The practical result, over time, is that when market interest rates increase, people are inclined to spend less on goods and services. This is because their savings get a higher rate of interest and there is an incentive to save; and conversely, people with mortgages and other loans may experience higher interest payments.
When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce. Although the OCR influences New Zealand’s market interest rates, it is not the only factor doing so. Market interest rates – particularly for longer terms – are also affected by the interest rates prevailing offshore. New Zealand financial institutions are often net borrowers in overseas financial markets. Movements in overseas rates can lead to changes in interest rates even if the OCR has not changed. (source: taken from RBNZ website)
How does the OCR actually affect interest rates?
The OCR was introduced in March 1999 and is reviewed seven times a year by the Reserve Bank. The OCR is actually the interest rate for overnight transactions between banks. Among other things, the Reserve Bank acts as the central bank for most registered banks in New Zealand, who hold settlement accounts at the Reserve Bank.
To explain, if you write out a cheque or make an EFT-POS payment, the money is taken from your bank and put into the bank of the recipient. This causes the money within your bank and every other bank to go up and down each day according to what their customers are spending or depositing. Depending on daily transactions, individual banks can end the day in credit or debit.
Much like an overdraft account, the Reserve Bank covers the ups and downs by either paying or charging interest to banks depending on whether they are in credit or debit. Banks can borrow money from the Reserve Bank at a rate 0.25 percent higher than the OCR, or lend money to it at a rate 0.25 percent lower than the OCR.
Short term interest rates are therefore influenced by the OCR because banks are unlikely to lend money to people for rates less than they could receive from the Reserve Bank, or to borrow at rates higher than they would pay the Reserve Bank.
By affecting overnight rates, the Reserve Bank has a strong influence on short-term interest rates such as the 90 day bill rate and floating mortgage rates.
However the impact isn’t direct and may not be immediate. While overnight interest rates will respond quickly, longer-term interest rates may not. Some overseas investors will respond quickly to changing interest rates, but most consumers and businesses won’t. Why does the Reserve Bank change interest rate?
As the OCR affects short term interest rates, if a majority of mortgages are on long term fixed rates, then the OCR will have little effect on mortgage rates. (Source: New Zealand Property Investors’ Federation website)
Why does the Reserve Bank change interest rate?
The Reserve Bank is responsible for implementing monetary policy in New Zealand. It operates under the Reserve Bank of NZ Act 1989 which states that the Bank must maintain price stability. The Bank also operates under the Policy Targets Agreement (PTA) that it signs with Government.
The current PTA, signed in September 2012, defines price stability as annual increases in the Consumers’ Price Index (CPI) of between 1 and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 percent target midpoint. The CPI is a list of 690 goods and services, whose prices are monitored by Statistics NZ to see if they are going up or down.
The Reserve Bank monitors the NZ economy and uses this huge bank of data to make predictions on where it sees the CPI and hence inflation is tracking. If the Reserve Bank believes that inflation is going to go beyond the range it has been instructed to keep within, it will use the OCR in an attempt to keep inflation within the range.
As interest rates rise, people spend less, either because there is an increased incentive to save rather than spend or people with mortgages and other loans have less to spend. When people save more or spend less, there is less pressure on prices to rise, and therefore inflation pressures tend to reduce.
In addition to having an influence on interest rates, unfortunately the OCR has an effect on other economic factors. As interest rates increase, NZ becomes more attractive to overseas depositors, who buy NZ dollars to access the higher interest rates. This increased demand for the NZ dollar increases its value compared to other currencies which makes NZ products more expensive in overseas markets.
One reason the Reserve Bank introduced restrictions on Loan to Value Ratios (LVR) was to influence inflation. The theory is that if people are required to have higher deposits when buying property, this will encourage them to save more to get a higher deposit. This reduces spending as well as the risk of over borrowing, while not having an effect on the exchange rate.
As with anything the Reserve Bank does there will be winners and losers as a result of these restrictions. This then begs the question, have we got our inflation targets set correctly in the first place?
Mainstream banks have started to respond to the LVR (Loan to Value Ratio) restrictions following the Reserve Bank’s announcement on November 29th 2017.
LVR on Investment properties
Most major banks have indicated that, as of 1st January 2018, they will begin lending up to 65% on investment properties (up from 60% this year).
Let’s say a couple have their own house and want to buy an investment property, both valued at $500,000. Previously they could borrow up to 80% on their own home ($400,000) and 60% on the new investment property ($300,000). In other words, the total borrowing on their $1 million property portfolio would be $700,000.
As of the 1st January 2018, the same couple will be able to borrow $400,000 on their own home as before. But now they will be able to borrow $325,000 (65% LVR) for a total borrowing of $725,000.
Is this enough?
With the new rules, it is slightly easier to borrow to purchase an investment property. It won’t open the flood gates but buyers who are currently just short of being able to buy may find themselves back in the market. I think this is exactly the outcome that the Reserve Bank are hoping for.
Low (high LVR) Deposit Buyers
There has been some confusion around this change of policy. Currently, 10% of any bank’s new owner-occupied mortgages can be lent to clients with less than 20% deposit. In other words, those with higher than 80% LVR.
The LVR mark is still 80% however the banks can now lend up to 15% of their new owner-occupied mortgages to low deposit buyers.
And banks are already indicating how this is going to change. One bank, who has recently declined almost all mortgages over 85%, has indicated that they are now more prepared to look at up to 90% again.
Is this enough?
A mere 5% increase in available lending doesn’t sound like much. But the question has to be asked, what percentage of lending goes to low deposit buyers if there are no restrictions? Of course, it’s not 100%. A large portion of mortgages will always to be low LVR owners simply due to the nature of capital growth.
Given this, I think the change to the available lending is going to more significant than it initially sounds. And the great news is, this is going to affect first home buyers the most (for the better). This will allow those with a deposit hurdle more of a chance to get into the home they want.
Some exciting changes are happening to the property market. The 2 main changes are:
- Investment property buyers no longer require as much deposit to purchase
- Low deposit borrowers have a better chance of being able to get a mortgage if they are borrowing >80%
A common phrase in mortgage world is the “one bank trap”. It’s when you have all your lending with one bank which gives the policy makers at the bank all the power and lowers your negotiating power. If the bank’s policy changes, all your investment eggs are in the same basket.
But if you spread yourself too thin, you create a different type of nightmare.
Let’s use Joe Bloggs as an example. Let’s say he has 5 investment properties with $1.5m of mortgages. For this simple example, let’s say he has no personal debt. How should he spread his mortgages?
The One Bank Trap theory says that if all his debt is with one bank he’s exposed to their rates and their rules. He also can’t play the other banks off against each other.
But lets look at the other extreme. Spreading his 5 properties across 5 banks means he could give each bank $300k debt each (assuming all properties are equal value). But this means each bank is hardly making any money on their slice of the mortgage. He also now has 5 internet logins and a large stack of eftpos cards in his wallet.
My general rule of thumb is to give a bank around $1m of lending and then look around for another bank. In this case he might give the first bank 3 properties and $900k of lending. This would certainly put him in the “preferred category” and would also mean he is likely to get the best rates.
He can then diversify the rest of his borrowing to a second bank. He might give them $600k and using the first bank’s rates to negotiate the second bank lower.
In summary, become a premium client with one bank by borrowing more than, or close to, $1m. Once you’re there, begin to diversify. Don’t get too hung up on the One Bank Trap before you need to.
About 3 years ago, 80% of all mortgages were sitting on a floating rate. And with good reason. The interest rates were falling off a cliff. In a couple of years, fixed rates had gone from ~10% to 5% so fixing your mortgage for any number of years didn’t seem like good maths.
Nowadays, the pressure on interest rates seems to be up (or at least flat). Interest rates are still at comparatively historic lows so fixing seems like a good option but there are some questions you need to ask yourself before going ahead with fixing your mortgage.
Do I have some savings that I can use to reduce my loan?
If you have been paid a bonus or have managed to save up some money, re-fixing is a good time to pay down your mortgage. There won’t be any break fees and the money will not be available to tempt you to spend. If you use a Revolving Credit account and have paid this down, you can pull the money out of there, pay down your mortgage and begin to pay down the Revolving Credit all over again.
Am I likely to sell my house while the fixed period is in effect?
If you sell a property and the mortgage is fixed, there is a small chance you may have to pay a break fee. When you fix your mortgage, you’ve promised the bank to borrow $… over … years but by selling before the maturity date, you are breaking this promise. The bank needs to repay the people who have leant them money and this can come with a fee. If you are looking to sell, consider a shorter fix period (eg; 6 months) or if it is very close, consider leaving it on floating and negotiating a discount on that rate.
How easily can I make additional payments after fixing the loan?
In NZ, banks have 2 methods of making extra payments on a fixed loan (without break fees). Most allow you to increase the payments by up to 20%; so if you are paying $500 per week, then you can increase it to $600 per week with no penalty. The only caveat is that you cannot reduce those payments again until the end of the fixed rate.
One bank allows you to pay up to 5% off the amount owing without break fees. So if you have a $500,000 mortgage, you could pay $25,000 per year off without penalty (there is a $100 admin fee though).
It’s important to know which method suits you and choose the bank accordingly. Paying even a little extra money off your mortgage can save you tens of thousands of dollars down the track.
At The Mortgage Lab, we walk our clients through their mortgage refix at no cost. Feel free to give your Adviser a call to discuss your options.