New Zealand’s interest rates variations and its impact on Home loans

The Reserve Bank of New Zealand (RBNZ) has followed a policy of consistently lowering the interest rates over the last 8 years; as a result New Zealand now has one of the lowest interest rates in the world. Before looking at the impact this has had on the local housing sector, let us first look at the drivers of interest rate in order to understand why interest rates in New Zealand have been falling consistently.

Interest rate is a monitory policy tool which is used to control the supply of money in an economy and the supply of money is linked with the rate of inflation. Therefore, interest rate to a great extent is linked with inflation.
A rise in inflation indicates a rise in the general price level, which indicates that the purchasing power in an economy is reducing, if this is not in line with the government policy then the government decides to increase the rate of interest to cancel out the effect of inflation. Rise in the rate of interest means that loans become expensive and deposits become attractive, this reduces the level of spending in an economy, thus driving down demand and pulling the price levels down.
Now that you know how interest rates and inflation are linked, let us look at what has happened with the interest rates in New Zealand in the last 5 years and its impact.

Year Interest Rate Inflation (Y.o.Y)
2015 2.50 0.31
2016 1.75 0.31
2017 1.75 1.85
2018 1.75 1.85
2019 1.00 1.94

As it can be seen from the table, year on year inflation in New Zealand has increased, although this rate of inflation is well below what is present in other countries. Such a low rate of inflation is considered as a stable and healthy rate, however in this case it is slightly unhealthy as the local markets are showing signs of slowing down. If we read the interest rate side by side, then we can see that over the last five years, interest rates have steady declined. There is an inverse relationship here between interest rate and inflation.

The steady decline in interest rate suggests that the government wants to increase spending by making loans cheaper and discouraging savings. The steady and controlled rise in the rate of inflation corresponds to this policy as it shows that the level of spending has increased gradually, perhaps not as much as the government intended.

Interest rates directly influence the lending rates of loans and if we look at the house mortgage or home loans market, then the effect is the same.

Earlier this August, when the RBNZ cut the interest rates to 1%, many experts suggested that this is the ideal time to buy property in New Zealand because most people enter into house mortgage or home loan to purchase property and since interest rates are at their lowest ever, this means cheaper mortgage rates. Soon after the announcement from RBNZ, Kiwibank announced to pass on the complete effect of cut down by reducing its rates on floating (variable rate) loans; other banks such as ANZ, Westpac, ASB and BNZ have also cut down the interest rates on their floating and flexible home loans.

Home loans or mortgages are the most common way for an average family to purchase their own property. A home loan or mortgage is one where the asset in question is held as collateral by the bank till the mortgage amount is fully paid off. The repayments are made in monthly installments where each installment comprises of interest and principal. With each payment the outstanding amount reduces, till it reaches zero at the end of the term of mortgage at which point the title of the property is transferred to the owner. Some mortgages have an early payment penalty clause, where the penalty is usually a percentage of the outstanding amount and this clause serves to safeguard the interest payments which the lender would have received had the borrower continued to pay the mortgage according to the terms. Most mortgages are taken out for 30 years and if the borrower wants to repay the mortgage early then a viable option is to renegotiate the mortgage down to 15, 10 or 5 year terms instead of paying the remainder early and incurring early payment penalty.

Home loans are connected with the housing sector and the demand for home loans is directly linked with the demand and market conditions of the housing sector. While the economy as a whole has shown signs of slowing down (which is why the government has consistently reduced interest rates), the housing sector has shown a completely different trend. In the last decade the housing sector has gone through a boom phase and now many experts are calling it a bubble which may burst at any time. This bubble is however, now showing signs of slowing expansion.

In March 2009, the value of housing sector stood at approximately $568 billion and almost 9 years later in January 2018, this figure stood at $1067 billion. This amounts to almost 87.8% increase in the value of the housing sector over eight years.

This has both positive and negative implications for the local economy. It created high demand for the housing sector and thus creating high demand for house mortgages, since the median price of an average property in New Zealand is around $ 580,000 and many New Zealanders cannot afford to buy this in cash, thus house mortgage is the best option to buy their own property.

However on the negative side, this means that the prospects of buying their own property are reducing for many people because the interest rates on savings are low as the policy of the government is to promote spending. If they people have low savings, it becomes difficult to take out a mortgage and pay for it directly from the monthly pay cheque, especially when the latest house price index figures suggest that housing prices in New Zealand have increased by 2.9% in the month of August and by 8.3% in the last 5 years.

Going back to the inflation figures, if we see the increase in inflation in last 5 years, it amounts to 1.63% since 2015 now if you look at the 8 year rise in house price index, it stands at 8.3%. This clearly shows that the housing sector is inflating at a faster rate as compared to rest of the economy.

This phase of boom or bubble, by many experts is considered very dangerous and it is estimated that if the bubble bursts, it`ll wipe approximately $60 billion from the housing sector. This also points toward the fact that house loans are in high demand because the demand for housing is high. This demand is affected by multiple factors and the gradual reduction in the rate of interest is one such factor because it has made house mortgages cheaper and more accessible.

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