Rosie Smyth and Richard Larsen, along with their toddler daughter, had spent years looking for an affordable home in Lyttelton, a small harbor town on the outskirts of Christchurch where Smyth grew up.
They were on the prowl in the midst of New Zealand’s affordability crisis, when prices rose to nearly nine times median incomes. There was a frenetic quality to the market — every month seemed to see a new rise, and with it a sense, says Smyth, that if you don’t get in now, prices could dance permanently out of reach.
At the beginning of 2022, the family finally managed to buy a house and the relief was enormous. “I really didn’t realize how much weight would be lifted if we got a house, in a community where I’m from — so many things came off my plate,” says Smyth. “The fear that that will change again is quite high.”
Now New Zealand homeowners are looking down on an era of financial instability: huge jumps in interest rates will strain the budgets of many households, especially those who bought in the past three years, when the market was at its peak. On Wednesday, the Reserve Bank raised its official cash rate by 75 basis points to 4.25% in an unprecedented effort to combat the country’s stubbornly high inflation.
A number of factors make the country’s housing market extremely vulnerable to a crash: it has one of the world’s highest price-to-income ratios and most mortgages in New Zealand are locked in very short terms of one to three years, about half of which are of all mortgages to be refinanced next year.
The interest rate rises mean that when many New Zealand homeowners are forced to refinance their mortgages, they will do so at rates more than double or triple the current rates.
Smyth and Larsen are in a safer position than many – they split their mortgage into multiple installments and don’t face having to refinance the whole thing this year. If they did, the impact would be huge, Smyth says. “I think we would probably reconsider having another child,” she says.
‘I’m a single parent, so… it’s all on me’
Melissa Derby, a university lecturer, bought her home in Tauranga in December 2019 when the official cash rate was 1.0%. Part of her mortgage is due to be refinanced in January. If she refinances, her mortgage interest could triple, potentially adding hundreds of dollars in monthly payments.
“What it would mean to me is that instead of having a surplus of income from, say, my salary, a significant portion of that now goes on the mortgage,” she said. “I’m a single parent, so that kind of adds to the mix — it all falls on me.”
She has already started planning the attendance. “I’m definitely going to have to be a lot more careful with my money — being very careful at the grocery store, changing the types of foods we eat to stretch things out a bit more,” she says. Money she had saved for a holiday with her son next year is now being funneled into the mortgage.
These kinds of calculations — whether they’re going on vacation, dining out for a birthday, or handing out a Christmas present — will be made across the country as households look at their budgets and gauge whether they can absorb hundreds or thousands of dollars in extra payments on their budget. mortgage. Collectively, those small decisions will send shockwaves through the wider economy.
“If you think about people dumping their mortgage, defaulting — people won’t,” says Dr. Michael Rehm, a senior lecturer in real estate at the university. “People will literally eat rice and beans…and leave out all the beauty of life, and they’ll pay the mortgage.”
The sectors that will feel the pain are services, tourism, hospitality and small businesses – many of the same sectors that suffered most during the pandemic.
“That’s terrible for the economy — because so much money is being sucked out of the economy and it’s being diverted to pay interest, which in this country largely goes to foreign banks,” says Rehm.
It is this phenomenon that makes housing shocks a particular threat to the wider economy. University of California economists have argued that credit-financed housing price bubbles are the most dangerous type of bubble to trigger a financial crisis. Another study found that “consumption falls by five to seven cents for every dollar of net wealth that falls in the housing market.”
‘Just cool the jets’
In the case of New Zealand, a limited or ‘shallow’ recession is exactly what the Reserve Bank (RBNZ) is aiming for. “Think more about your spending. Think of saving instead of consuming, I know that’s a strange concept,” Reserve Bank Governor Adrian Orr said Wednesday. “Just cool the jets.”
But cutting household spending is a blunt tool for controlling inflation, and banking economists say it paves the way for a bleak and rocky year ahead.
“Make no mistake, the RBNZ is not just signaling a recession, it is predicting a recession on a similar scale to the global financial crisis – different causes, but similar impacts,” said Michael Gordon, Westpac Bank’s acting chief economist. “For the first time in a while, we are also thinking about the risk that the RBNZ could overcook it on inflation.”
House prices in New Zealand have started to fall sharply this year. In Auckland, the country’s largest city, average prices fell 12.7% year-on-year last month, while the rest of the country fell 7.5%.
Residential investors will feel the heat from a number of policy interventions on top of rising interest rates: a capital gains tax on properties bought and sold within 10 years, and the loss of interest deductions on their tax bills.
The next question, Rehm says, is, “If we’re going to finally see those investors just say OK, to deal with it, sell it at any price – you really should see a collapse in house prices, a collapse in the market. ”
Since most of New Zealand’s total wealth – over 57% – is tied up in housing, that could also mean many households’ primary assets are evaporating.
“So much debt is held by households in this country, by owner-occupiers and investors,” says Rehm. So much wealth will … evaporate as house prices collapse.”