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.
It’s that time of the year when the Reserve Bank releases all it’s statistics on current and new mortgages. The statistics are broken down into new lending, existing lending, interest only and principal and interest payments.
Some highlights from the release are:
- $5.85b of total new lending in March
- as you would expect this is up from $4.6b in February 2018 and $3.7b in January but down slightly from almost $6b in March 2017 and $6.6b in March 2016
- Noticeably, Interest Only lending has reduced significantly. In previous years, Interest Only for new lending was 34% (March 2017) and 40% (March 2016). This March, Interest Only lending for new mortgages represented 28.8% of new loans
- 27% of existing lending is currently on Interest Only
Interest Only reduction
The Reserve Bank has previously indicated that they would like the banks to reduce the amount of mortgages on Interest Only even further. As a result of this, a number of banks have implemented strong measures to ensure that clients aren’t perpetually keeping their mortgages on interest only loans.
And this is a good thing. It is not a good strategy to keep your mortgage on Interest Only indefinitely. If interest rates increase, you are liable for significantly higher payments. The more you pay off your mortgage, the less risk you have with increasing interest rates.
Interest Only and Property Investors
But property investors who are already making additional payments on their personal mortgages are not being allowed to keep their investment mortgages on Interest Only.
Mortgage Tip: It’s a standard financial strategy to keep all your investment mortgages on Interest Only while you pour your money into paying down your personal mortgage. Only once you have paid off the personal mortgage, you begin to pay down the investment portion.
But banks are declining Interest Only extensions even for clients who are making large payments to their mortgage. Most New Zealand banks now limit an Interest Only term to a maximum of 5 years before the client is required to begin paying down their mortgage. However, it’s this kind of one-size-fits-all policy that is costing investment clients by reducing their tax liability.
There are banks, for example, that are simply refusing to extend Interest Only periods for any clients with over 70% LVR (Loan to Value Ratio). As a result, we have clients who are now having to divert their personal mortgage payments to pay down their investment mortgage. It still results in the mortgage being paid in the same amount of time but has severely disadvantaged the client from a tax perspective.
The war on property
In the past 10 years, property investors have had several advantages taken away from them that previously made property more lucrative. The removal of claimable depreciation in Budget 2010 followed by the introduction of the bright-line test in 2015 which applied a capital gains tax to properties bought and sold in less than 2 years. The bill (https://www.parliament.nz/en/pb/bills-and-laws/bills-proposed-laws/document/BILL_72842/taxation-annual-rates-for-2017-18-employment-and-investment) to extend the bright-line test from 2 years to 5 years has passed it’s third reading and will become law.
Since 2013, property investors have only been able to borrow up to 60% LVR on investments properties with this being lifted to 65% in January 2018.
Interest Only is different
The previous policies were designed to cool an extremely hot property market and, to a large extent, this has been successful. The LVR rules, for example, were put in place to limit the investors that were crowding out the first home buyers. But these Interest Only policies that force investment property owners into a disadvantaged tax situation benefit no one. They were paying down their mortgage and staying within the rules with their tax deductions. Why are they being targeted?
It seems that the banks are turning a blind eye to situations where clients are paying their personal mortgage because it would be too hard to monitor.
But realistically, it would take a very simple assessment: are the proposed Principal payments going to pay down the entire mortgage in 30 years or less (for a new mortgage)? If so, the clients should be able to place any mortgage up to the maximum value of their investment properties on Interest Only.
The solution
It could be time to change banks if you are quickly paying down your personal mortgage but your investment mortgage is not being extended by your bank. A new bank should allow you to reset that 5 year stopwatch and place the investment mortgage on Interest Only again. There are some important caveats to this:
- You need to be making additional payments on your personal mortgage so that your entire mortgage will be paid off in at least 30 years (or sooner)
- It may not be financially feasible to change banks if you are going to be charged break fees. Before changing, compare the interest rate savings, total cost of break fees and the tax advantages that you will gain or lose
Today, the Reserve Bank kept the official cash rate unchanged at 1.75%.
Reserve Bank of New Zealand OCR Statement
The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 1.75 percent.
The outlook for global growth continues to gradually improve. While global inflation remains subdued, there are some signs of emerging pressures. Commodity prices have continued to increase and agricultural prices are picking up. Equity markets have been strong, although volatility has increased. Monetary policy remains easy in the advanced economies but is gradually becoming less stimulatory.
GDP was weaker than expected in the fourth quarter, mainly due to weather effects on agricultural production. Growth is expected to strengthen, supported by accommodative monetary policy, a high terms of trade, government spending and population growth. Labour market conditions are projected to tighten further.
Residential construction continues to be hindered by capacity constraints. The Kiwibuild programme is expected to contribute to residential investment growth from 2019. House price inflation remains moderate with restrained credit growth and weak house sales.
CPI inflation is expected to weaken further in the near term due to softness in food and energy prices and adjustments to government charges. Tradables inflation is projected to remain subdued through the forecast period. Non-tradables inflation is moderate but is expected to increase in line with a rise in capacity pressure. Over the medium term, CPI inflation is forecast to trend upwards towards the midpoint of the target range. Longer-term inflation expectations are well anchored at 2 percent.
Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.
Our Take:
GDP and Inflation
As expected, the Reserve Bank held interest rates at a record low and indicated it does not expect to raise them anytime. That is, as long as economic growth loses momentum and inflation remains subdued. The soft landing of NZ Gross domestic product was confirmed last Thursday, March 15, 2018, when it only increased 0.6 percent in the fourth quarter, just missing the RBNZ’s projection of 0.7 percent. Adding salt to the weaker than expected GDP wound, economists predict growth in the first half will fall short of the central bank’s forecasts as business confidence remains weak. Slower growth adds to risks that inflation won’t pick up as quickly as the central bank expects. In its February projections, the RBNZ predicted inflation would lift to 1.8 percent by the end of 2018 — near the midpoint of its 1-3 percent target range.
NZ vs US
Likewise, we have to bear in mind that New Zealand’s benchmark rate has been at a historic low since November 2016 as exchange-rate strength and weak global inflation exert downward pressure on prices. Even as the Federal Reserve raises interest rates and says it is wary of emerging price pressure in the U.S., few economists expect an RBNZ rate increase before 2019. An expectation is contrary to the central bank previous monetary policy that signalled in February that rates would be unchanged until mid-2019, and since then economic growth has not revived as much as it expected.
No wonder why the New Zealand dollar was little changed after the statement. According to Bloomberg, all 16 economists surveyed by Bloomberg expected today’s decision, and most forecast the OCR will remain at 1.75 percent until next year. In addition, traders have reduced bets on a rate rise this year, pricing just a 31 percent chance of a move, according to swaps data compiled by Bloomberg today. Also worthy of note, the central bank governor Spencer omitted any comment on the exchange rate in today’s statement.
A change of leadership
Spencer, who has been in a caretaker role the past six months, steps down next week. New governor Adrian Orr will be charged with implementing the biggest reforms at the central bank in almost three decades as the government introduces a Fed-style dual mandate of full employment and price stability. It also proposes adding external members to the RBNZ’s policy committee.
While New Zealand’s economy has been expanding at a healthy clip the past several years, supported by immigration and booming tourism and construction, growth has stuttered as capacity constraints curb building activity. Business confidence is only slowly recovering from the eight-year low hit in November as firms remain uncertain about how the new government’s policies will affect them. Still, consumer confidence has rallied and the housing market has also stabilized after a rapid cooling in 2017. Annual house-price growth was 6.5 percent in February, Quotable Value New Zealand said this month. As the US Federal Reserve indicated that there will be at least two and probably three more +25 bps hikes in 2018, most likely RBNZ will be tempted to join the bandwagon as started by the US Federal Reserve. The US benchmark could be 2.50% by the end of the year while RBNZ OCR is still at 1.75%.
Today, the Reserve Bank kept the official cash rate unchanged at 1.75%. It also continued to signal rates won’t lift until mid-2019 at the earliest due to the lack of inflationary pressure.
Here are our notes from today’s announcement:
House Price Inflation
The Reserve Bank has noted a rise in house price inflation, while it has also revised down the economic impact of the new Government’s measures. It says that annual house price inflation is forecast to stabilise at around 2% in the medium term. The observed increase in monthly house price inflation over the second half of 2017 “is assumed to be short-lived”.
The Reserve Bank says that given low interest rates and excess demand for housing, house prices could rise by more than it assumed. It says the KiwiBuild housing programme is expected to generate faster growth in residential investment from 2019.
Annual Consumption
The Reserve Bank says annual consumption growth slowed to 3.4% in the September 2017 quarter. An increase in government transfers and allowances is expected to raise household incomes and contribute to consumption growth over the projection. Consumption is also expected to be supported by low interest rates, elevated terms of trade, and population growth. Low house price inflation is expected to have some dampening effect on consumption over the medium term.
GDP
The Reserve Bank has trimmed back short-term forecasts for GDP growth to 1% from 1.2%. It does also see stronger GDP growth later in this year and into next year. It now forecasts 1% growth in the March 2019 quarter versus an earlier forecast to 0.7% made in its last Monetary Policy Statement in November.
In terms of inflation, the Reserve Bank has responded to weaker than expected recent figures. It’s done this by trimming where it sees annual inflation ending this year at. Earlier, it saw annual inflation of 2.1% by the end of this year, but now it iss forecasting 1.8%.
Summary
It appears that the OCR chart above is eventually heading to the upside. The Reserve Bank today kept the rate unchanged at 1.75% and has done since January 2017. The possible catalyst for this move could be the domino effect of the overseas interest rates hikes – particularly the US – despite the local lack of inflationary pressure.
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).
Example:
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.
Summary
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%