History and data tell us that fluctuations in the property market are closely correlated to interest rates. If we look at the relationship between the Property market and interest rates, over the past 12 years, it is clear to see that the property market picked up anytime interest rates dropped. The lower the interest rates, the higher property values climbed – as interest rates reached record lows in 2020 and 2021 and borrowing money became ‘cheap’, property values in New Zealand reached unprecedented levels.
In 2022, mortgage rates started to climb again after the Reserve Bank of New Zealand (RBNZ) lifted the Official Cash Rate (OCR). During COVID, the RBNZ lowered the OCR to help stimulate the economy, however inflation subsequently surged to a record high of 7.2% by late 2022. The RBNZ uses the OCR to manage inflation to ideally sit within 1% to 3%, so between August 2021 and May 2023, the OCR was incrementally lifted from 0.25% to 5.5%, which has led in parallel to rapid increases in mortgage rates over the same period.
In the last 18 months, mortgage rates have more than doubled from the 3% average range in mid-2021 to the current 6% average range. These increases are starting to see many property owners exposed to a rapid rise in mortgage repayments, which directly impacts property demand. Not only do higher interest rates limit the amount that can be borrowed, but people are simply more cautious during periods of high-interest rates. Consequently, the rapid rise in interest rates from late 2021 has led to the current impact of a downturn in property values.
The effective mortgage rate borrowers were paying at the end of Q1-2023 was 4.7%, up from the record low of 2.8% in Q3-2021. The RBNZ projects the effective rate to rise to over 6% by Q3-2023 as existing borrowers refix from their low COVID-era mortgage rates.
Graph 1 – Valocity Value and Fixed Mortgage Rates
How did the mortgage rate affect the value?
Valocity has analysed the impact of mortgage rate changes on values using the Valocity Value Index. The Valocity Value Index tracks the average value of New Zealand Residential and Lifestyle properties. The Index is designed to incorporate a range of sources of property and sales data, ensuring that estimates provided are utilising the most recent information.
Historically, falling mortgage rates stimulate the housing market, and rising mortgage rates depress market growth. The post-COVID property market followed the same trend.
During the first COVID lockdown in 2020, the RBNZ had lowered the OCR to a record low of 0.25%, and consequently, the lowest mortgage rates on record were available in market. The Valocity Value Index experienced rapid growth throughout the latter half of 2020, and through 2021. Between March 2020 and February 2022, the national Valocity Value Index rose by 41%.
As mortgage rates began to rise from mid-2021 as inflation and the OCR rise, the market growth slowed in the latter half of 2021. The Valocity Value peaked in February 2022 nationally, with individual regions peaking throughout Q1-2022. The national Valocity Value Index has declined by 13% since its peak in 2022.
How are interest rates set?
The OCR is one determinant of mortgage rates, but not the only one. Other factors include global interest rates, inflation, and the length of mortgage terms. Generally, when the OCR rises, mortgage rates also rise, however not always by the same quantum.
Post-COVID, supply chain disruption caused global inflation to surge leading to benchmark interest rates rising throughout 2021 and 2022.
Exacerbating the issue in New Zealand has been the record low-interest rates introduced by the central banks during the initial COVID lockdown periods, which fuelled consumption and inflation. Now New Zealand, and many other parts of the world face a similar problem with record-low interest rates rapidly increasing over a short period, leaving many borrowers exposed.
Graph 2 – OCR and Standard Fixed Rates History
The mortgage rates set by banks followed a similar trend to changes in the OCR. Floating rates tended to be higher than fixed rates. Floating rates offered borrowers greater flexibility but no certainty. Two-year fixed rates have been higher than one-year rates, but the differential has narrowed over the past six months as we approach peak mortgage rates. The pace of increase has stabilised over the past quarter as the risk of recession increases and a likelihood of OCR rates being cut in 2024.
The workings of a mortgage
The most common type of mortgage is ‘Principal and Interest’ (P&I). That is, the payment is fixed, but the proportion of the repayment attributed as interest declines as more of the principal is repaid. The interest rate exposure is higher for those early in their mortgage terms because the higher the interest rate, the greater proportion of the repayment is attributed to interest.
Valocity analysed both 6% and 3% mortgage rates repaid via weekly payments for 25 years. A borrower on a 6% rate would pay 121% more than a borrower with a 3% interest rate calculated over the loan’s lifetime.
Graph 3 – The breakdown of mortgage payments at 6% interest
Graph 4 – The breakdown of mortgage payments at 3% interest
In these scenarios, a 3% mortgage rate enables 47% of the initial repayment to contribute to repaying the principal, and the proportion increases as time progresses. Compare this to a 6% mortgage rate where just 22% of the repayment initially contributes towards repaying the principal.
The 6% mortgage rate requires a 36% higher initial repayment, whereas the lower mortgage rate allows for faster principal repayment and less interest paid overall.
The real-world impact of the recent rate increases
Valocity investigated the real-world impact of the interest rate changes over the past four years using the following scenarios:
- Property purchased in January of each year over the past four years based on Valocity Value at the time
- 25-year mortgage term
- Prevailing one-year fixed rate
- Refixed the mortgage rate the following January at the prevailing one-year fixed rate
Graph 5 – Changes in Repayment at prevailing mortgage rate
Buyers who purchased in 2019 experienced a 4% decrease in repayments due to declining interest rates. In 2021, borrowers benefited from lower repayments after the RBNZ lowered the OCR to stimulate the economy post-COVID.
However, as inflation surged in mid-2021, interest rates increased, resulting in higher repayments. Throughout 2022 and 2023, repayment amounts have increased, most notably up to 29% in 2023.
Buyers who purchased in 2022 are the most adversely impacted and have experienced the most significant increases as they have larger loans and are earlier in their repayment cycles. A greater proportion of their repayments are currently attributed to paying interest rather than repaying principal.
Who is the most adversely affected by rising interest rates?
Mortgage rates increases apply uniformly across the country, so the areas most adversely affected by rising rates are those who paid higher purchase prices. We have assessed the real-world impact on purchasers who bought in January 2019 in New Zealand’s main cities, looking at the increases they experienced during COVID and the current interest tightening period.
Graph 6 – Changes in Repayment – main centres
As interest rates fell, repayments slightly declined in 2020 and 2021. When the rates began to rise in mid-2021, borrowers were negatively affected at refix in January 2022 and 2023. However, this group has been somewhat sheltered from steep repayment increases because they purchased before the market peak.
As per the scenario in the previous section, those worst off are buyers who purchased at the market’s peak in early 2022. They are likelier to have the largest loans as they had bought at the market’s peak. They also face the fastest rising OCR since its inception, rising by 4.5% between February 2022 and May 2023. Previous rate-tightening cycles have seen a slower pace and scale of increases.
Graph 7 – Changes in Repayment – purchased in January 2022
Outlook for the future
This year, mortgage rate increases have slowed despite inflation remaining high. Some banks are now offering lower long-term rates compared to short-term rates, which may indicate they anticipate an imminent peak in interest rates.
The Government’s recent Budget has placed additional inflationary pressure on the economy. The RBNZ warned the OCR is set to remain restrictive as they bring Consumer Price Inflation back to the 1%-3% annual target range, while supporting maximum sustainable employment. High-interest rates are still needed to slow demand and lower headline inflation further.
Mortgage arrears have risen in Q1-2023 but remained below the period immediately post lockdown.
Lower house prices throughout 2022 and early 2023 offset some of the impacts of the high-interest rates as the loan size required was lower. However, the question on everyone’s mind right now is when will rates fall again? It is too early to tell, with inflation remaining high at 6.7% and unemployment low at 3.4%.
Despite homes purchased during the peak period now likely seeing value loss today, as long as they don’t plan to sell and can manage the higher repayments, the owners will be able to hold on until the next rates loosening cycle.
Watch this space.