Why Are NZ Banks Turning Cautious On Interest-only Mortgages?

Friday, 1 July 2022, 2:21 pm
Press Release: Kalkine

Summary

• The NZ housing market has shifted drastically over the pandemic, with mortgage lending becoming a focal point of banks.
• Interest-only lending has declined in proportion to the total number of mortgage loans given to investors and owner-occupiers.
• Banks have tightened their lending criteria, and demand-side factors have also led to lower interest-only mortgages offtake.

The New Zealand economy has been marked by rising interest rates and increasing inflation. In these strenuous times, mortgage holders have faced the toughest challenge of managing household expenses. Considering rising inflation, banks have also changed their lending approach, becoming more risk-averse.

Commercial banks have been affected by the Reserve Bank’s decision to raise the official cash rate. The OCR hike has been passed on to consumers through higher mortgage and borrowing rates. However, there is a significant population currently holding mortgage loans. This population will be highly affected by rate hikes as their monthly repayments will spike by a large margin.

Meanwhile, interest-only mortgage holders could see even more challenging circumstances once their interest-only period ends. Interest-only mortgages are a lucrative option for home buyers in times of distress. Buyers choose interest-only mortgages when they are falling short of cash and expect an increase in income in the future. A buffer period allows buyers to manage personal expenses along with interest payments.

NZ banks offer interest-only mortgages with an interest-only duration of 2 years in case of personal homes and 5 years in case of investment property. However, it is important to note that interest-only mortgages have become less popular in New Zealand over time.

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A more conservative approach by lenders

The pandemic has changed the fundamentals of the mortgage market in New Zealand and in many other countries. The past few years have seen rapidly changing trends and a swift change in the approach taken by lenders.

During the initial lockdown phase, when interest rates had been lowered, commercial banks had developed a more open approach to lending. However, with time this openness has waned. Banks have become more cautious about mortgage lending, and extra attention is being given to interest-only loans.

Just over the past two years, interest-only loans have become less significant. CoreLogic reports suggest that interest-only lending remained relatively stable for investors in 2022 but has been on a gradual decline for owner-occupiers. According to CoreLogic data, the share of interest-only lending in the new lending flow among owner-occupiers has slid from over 30% in 2015 to less than 20% in September 2021.

Additionally, the overall trend in interest-only lending has shown a downward path for both investors and owner-occupiers. This is visible not just across the new investment flow but also across the existing stock. This shows the banks’ hesitance toward interest-only lending.

Rising age of paying off debt faster

There are certain instances in which interest-only loans can be a good option. Interest-only loans were considered a good option for investors as they can claim mortgage interest payments while filing their taxes.

However, the New Zealand Government announced that it would be phasing out tax deductions on investment properties from October 2021. This has also been one of the prime factors that have caused a decline in the popularity of interest-only loans, even among investors. However, investment properties bought before March 2021 would still receive some tax benefits till April 2025.

The mortgage dynamics have shifted so drastically that many household owners now find it more incentivising to pay off their loans as early as possible. In the present age of rising interest rates, homebuyers do not want to take up an obligation that lasts long.

Interest-only mortgages belong to the complete opposite end of the spectrum, as they increase the overall repayment burden on borrowers. Paying the principal amount in a lumpsum manner after the two- or five-year buffer period is even harder than repaying the principal with interest payments. Thus, investors and owner-occupiers both have shifted their interests from interest-only loans to regular loans.

With banks taking a stricter approach and demand factors showing a rising trend toward faster-repayment loans, interest-only loans are likely to appear as a lacklustre method of investing in property. Most active interest-only holders have also shifted to the principal repayment schedule, further reducing the prevalence of these loans.

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