David Hargreaves ponders the country's mountain of weighty mortgages, which, paradoxically, keep getting lighter and more affordable thanks to disappearing interest rates

This last drop in interest rate was surprising to me. Using up the ammunition prior to it really being needed in my view.

DP

Interest rate will continue to drop as the world needs zero rates to keep the oil pumping. It's as simple as that.

"People, particularly first home buyers, are having to borrow heroic amounts of money." Heroic ? Frightening more like it! The capacity to endure rising interest rates is slim to nothing, so any turn in the money markets could be literally catastrophic for the individual as well as banks in general. Banks must be either really confident they can manage the risk or supremely stupid and complacent about the level of risk they have taken on. Or do they perhaps have designs on being the largest property owners in NZ? Possibly believing the Government will allow them to flick on mortgagee properties to foreigners if they get saddled with lots? The other belief they will have is that they will get bailed out by the Government and the taxpayer. this is why they need to be robustly regulated.

"What if the house market does show some signs of turning up again? Remember it's still ticking over okay anyway in some parts of the country. Auckland of course is flat though."

Auckland isn't flat ~ its declining. Mortgage rates are declining because government yields, which drive swap rates have plummeted. This isn't good news as the bond market is telling us to expect no wage growth or inflation for a decade ~ yes, a decade.

Why is this news being overlooked and instead we get a plethora of articles on lower rates ? Anyone would thing this is a good news. It's not ~ good news would be real wage rises, diversification of the economic output of the country and yes ~ RISING rates as this is what you get when an economy is GROWING at a decent rate.

Great article David. I totally agree with your concluding paragraph:
"Generally I don't think anybody should plan for serendipity. Therefore it still worries the hell out of me that the current low interest environment potentially sets us up for big problems later if we do at some point start to see interest rates revert back to what we used to regard as 'normal' levels."
I hope FHB - or someone else with a large mortgage - note this and will be paying down principal as much as possible during this what is an abnormal period of low mortgage rates continues.
There is the complacency that $25,000 at 3.8% is costing less than $1,000 bucks a year which pales compared to interest on the credit card, so that deck, overseas holiday, or new car is really affordable.

Hi David, I'm interested in what measures you considered when defining the Auckland market as 'flat'. I would generally consider a market as flat if it was keeping level with inflation.

The HPI shows Auckland prices are falling 4.4% yoy, on very low sales volumes. Personally I would struggle to define that as flat.

We are in a multi decade trend of descending interest rates. It amazes me that for all the commentary on this few people ask why this is. I will go further and say any comment that ignores this canary in the coal mine is critically deficient. But hey we have free speech, and even an apparent democracy, where you can pretend you know something and comment anyway.

Agree on risk here.
Not on "flat". What is a "market". Is it just price?
Surely it refers to buying and selling.
REINZ website shows apartment sales in Auckland down 44% in May compared to 2018.
Also, it shows sales lower in first 5m of 2019 than they were in 2008.
That is TOTAL sales, not simply residential which is why REINZ puts in its press releases.
Average mortgage of FHB is not for Auckland.
RBNZ is under-counting because they take figures form individual banks and do not consider that people are borrowing multiple loans. SO risk is far higher.

"The key question is, do we believe interest rates at this level or only slightly higher are now a 'new normal'?"
- It's simple. We have inflation targetting in NZ. To achieve this increase of money supply we go to our favourite mechanism for introducing new money - home loans. Now, ironically as home loans aren't really that productive and we don't generate any extra income to help pay our debt so we now rely on inflation targetting to eat away the value of the loan. To achieve this inflation, we go to our favourite mechanism for introducing new money - home loans.
And so the cycle repeats. What we see is higher house prices, longer mortgages, lower interest rates. This cycle will repeat until it can't anymore and then pop (or at least some very creative and destructive policies from the party in power at the time to keep the cycle from breaking down).
We aren't exactly setting ourselves up for the future here...

The increase in indebtedness is Phil Twyford's fault (with help from Auckland Council).

Auckland is not flat in the traditional sense, it is undergoing a cost reduction phase with increased building activity (caused by the 2017 onwards land availability). If Phil Twyford had carried out Kiwibuild as he promised to, there would have been a greater cost reduction in the Auckland market and further increased building activity. This would have meant increased wage growth, improved economic performance and lower housing costs.

But because Phil Twyford is a completely useless lying politician, it has now become necessary to slash interest rates and consign a generation of home buyers to monstrous debt loads.

Various fantasies, Reserve bank is independent, there is no inflation
Facts government is drowning in debt, local government is drowning in debt, many households are too and a good proportion of farms and businesses.
Solution fiat money and keep interest low to avoid the house of cards collapsing. At the same time any real money stored by prudent savers should be eroded by low interest rates.
Savers prop up high geared debtors. The new normal is a construction by the financial sector and politicians treading a high wire and no safety net. Within this fiat money is laundered and mixed with real money and the scurrilous perpetrators get great bank balances.

On the article about where put term deposit money one of the suggestions I put forward was investing the money in mortgage payments. It works as a part of a diversified portfolio, and the return is acceptable. Despite there being greater returns elsewhere having a large pile of debt is a risk. The debt is denominated in NZD but the interest payments are a percentage. The 11% of the past caused a lot of people pain and they struggled to pay. Whereas I was on the other side collecting healthy interest payments.

While the rates are low now it only takes a currency issue to create massive inflation problems which leads to high interest rates. For example when sanctions hit Russia over their invasion and occupation of Crimea they had massive currency problems. I believe their interest rates climbed rapidly to 14%. Given the large number of $500,000+ mortgages and then apply 11-14% you get a large amount to pay and most likely a lot of defaults.

Take advantage of the low interest rates to invest and comfortably pay down debt.

"But, ohhh. It wouldn't take long for any even fairly small rises in rates to start causing real pain. Just as a very quick example if you added two percentage points to the current floating mortgage rate for a $400,000, 30-year loan, this would add $530 to the monthly interest bill. THAT would be noticed by the customer."

That's the crux of the article for me. Just eyeballing the historic mortgage rates graph, it's clear to see that rates can blip up and down by 50 to 100 bips over short time scales. The effect of such changes is much less at high rates than at low rates. So the vulnerability now that low rates seem - Seem - to be semi-permanent, is now heightened.

Average size mortgage is $400,000? Yeah right! In Auckland the mortgage sizes most are taking on are anywhere between $600k and $800k for first home buyers. The RBNZ have been getting their averages from mortgage portions, not the total amounts so the data is misleading.

It’s a dangerous situation, but we are complacent. As you say “our households are apparently drowning in debt. And yet. They are not. Not in terms of what they can 'afford'” at the moment. NZ housing values are still sky high in world terms. We only need to look at recent history to see what could happen, and we won’t be prepared for it: Ireland, Spain during and after the GFC, or Japan since their 1980s property (and stock market) bubble and bust. Interest rates could stay low, and go lower, and we’d still be in a lot of trouble because of our debt. The housing market is declining a lot in Australia, and their interest rates are historically low and going lower. We’ll be right though, eh?

The outcome will be falling home ownership rates whether mortgage rates continue to fall or if there is a sustained increase in mortgage rates. As GDP has been distorted by the sectors that support rising house prices and rising house sales for two decades, as one or other or both decline, growth will slow, the OCR will continue to fall. The group that will benefit the most from a rising OCR will be the very same group that benefits substantially at present.

I see Stephens at Westpac is talking up house price rises next year off the back of falling interest rates. But I fail to see how a cut here or there will have much impact.
Different story if the OCR is cut to zero, of course.

While I managed it somewhat, my focus was never on interest rates. But I sure spent a few decades obsessed with paying down principal.
Boy has it worked for me. No debt means high cash flow income, low anxiety and not being just an agent trying to chisel a small margin as they pass money on to the bank.
Currently all I have to manage is some rolling term deposits which are awaiting a building project.
Ditch the debt as best you can. Cent by cent if that is the way youhave todo it.

Including rental properties owned, the percentage figure for financial liabilities to annual disposable income as at March 2019 was 164%, which is also a record high. However, the figure's now been the same for 12 months, which is good news if you can call it that. Sitting on a high plateau. Back in December 1998 the equivalent figure was just 99%. So, our households are apparently drowning in debt. And yet. They are not. Not in terms of what they can 'afford'.

Maybe? The RBNZ had this to say:

The proportion of risky borrowers in the household and dairy sectors appears relatively high. Around two-thirds of households have no mortgage debt, but nearly 40 percent of new mortgage loans are to borrowers with DTI ratios above five. In the dairy sector, 35 percent of debt is to highly indebted farms, defined as farms with more than $35 of debt per kilogram of milk solids produced annually. However, less than5 percent of loans to the commercial property sector are to particularly risky borrowers,1 suggesting debt is fairly evenly distributed across the sector.

Link-page 7 (13 of 48) PDF

Moreover, the households with mortgages DTI(disposable) ratio increased marginally to a record high of ~320 percent at the end of 2018 (figure 2.3). Link-page 8 (14 of 48) PDF

Your first sentence is incorrect.
It's not odd. In a bubble (yes it's a bubble when prices appreciate faster than average wage), you need at least the same amount of credit expansion by percentage per year to keep inflated asset prices up. Even a drop in the rate of increase leads to dropping prices. This is all you need to know if you want to understand the falling OCR and interest rates.
The RBNZ and merchant banks don't want mortgages bigger than the value of the property they are written for. They don't want affordable housing. And they want more people to 'step up' and borrow. They will do everything to defend sky high property prices, and they've just about done everything they can to do it, bar allowing Chinese money back into the NZ ecosystem. If the temperament of New Zealanders is anything like Japan, people will become averse to borrowing huge amounts of money even at record low levels of interest. They just won't borrow. Or can't. Interesting times.

Of course if interest rates went up 3% or more it would be carnage on the streets, that's exactly why they're not about to rise. The RBNZ (and other RB's around the world) are fully aware of this and they are not interested in precipitating the next recession/depression, so interest rates will stay low for a long time and go even lower.

"One of the statistics closely looked at is household indebtedness in relation to disposable income"

Here lies the answer to your conundrum (and the mistake) it's wrong to compare financial position (debt or liabilities) with cashflow (income). Any half decent accountant knows this. Isn't there an accountant amongst our commenters?

I have given this example multiple times before; let's assume for argument's sake that an DTI of max 5 is acceptable. Today John has debt of $500k and earns $100k = DTI of 5. Today he pays 4% interest = $20'000pa. Let's assume interest rises back to 8%, John will then pay $40'000pa a very significant difference and he may well struggle. How much has his DTI changed? Not one bit, because it's wrong to compare D with I.

This time its different :)

With the signals being more OCR cuts, expect things to carry on the same. Most people are not going to put their life on hold for years waiting for a property crash, they are getting on with life and just buying a house. When was the last time interest rates were this low ? thats right NEVER. Also I cannot remember a time that the signals were for even more cuts. Yes its propping up the property market, but like I said when Labour got in, nobody wants to crash the economy on their watch so its everyone's best interst to keep the party going. Unfortunately no government can shield us from an external shock.

David, do some research. You'll find that the average interest rate over the last 300 years is around 3.8%.

Hint, start at Gilt yields, they have a long series. The 1970s-1990's were the anomaly, not the norm.

No need to say thanks.