Rosie Smyth and Richard Larsen, along with their toddler daughter, had spent years looking for an affordable home in Lyttelton, a small port town at the edge of Christchurch where Smyth grew up.
They were hunting in the midst of New Zealand’s housing affordability crisis, when prices rose to nearly nine times the average income. The market had a frenetic quality – every month seemed to bring a new rise, and with it the feeling, Smyth says, that if you didn’t get in now, prices could permanently dance out of reach.
The family finally managed to buy a home at the start of 2022, and the relief was enormous. “I really didn’t realise the weight that would be lifted when we got a house, in a community that I am from – just so many things came off my plate,” Smyth says. “The fear of that changing again is pretty huge.”
Now New Zealand’s homeowners are looking down the barrel of an era of financial instability: huge leaps in interest rates will pile pressure on the budgets of many households, particularly those who bought in the past three years, when the market was at its peak. On Wednesday the Reserve Bank raised the official cash rate by 75 basis points to 4.25%, in an unprecedented effort to counteract the country’s stubbornly high inflation.
A number of factors make the country’s housing market unusually vulnerable to a crash: it has one of the world’s highest price-to-income ratios, and most of New Zealand’s mortgages are fixed on very short terms of one to three years, with about half of all mortgages due to be refinanced in the next year.
The interest rate rises mean that when many of New Zealand’s homeowners are forced to refinance their mortgages, they will be doing so at rates that are more than double or triple what they are currently on.
Smyth and Larsen are in a more secure position than many – they split their mortgage into multiple chunks and are not faced with refinancing the entirety this year. If they did, Smyth says, the impact would be enormous. “I think we’d probably reconsider having another child,” she says.
‘I’m a single parent, so … it all falls on me’
Melissa Derby, a university lecturer, bought her Tauranga home in December 2019, when the official cash rate was 1.0%. Part of her mortgage comes up for refinancing in January. When she refinances, her mortgage rate could triple, potentially adding hundreds of dollars to monthly payments.
“What it would mean to me is that rather than having surplus income from my salary, for example, a significant portion of that is now going on the mortgage,” she said. “I’m a single parent, so that kind of adds a little to the mix – it all falls on me.”
She’s already begun planning for the rise. “I’ll definitely need to be a lot more careful with my money – being very careful at the supermarket, changing the type of food we eat in terms of making things stretch out a bit more,” she says. Money she had been saving for a holiday with her son next year will now be channelled toward the mortgage.
Calculations like this – whether to take a holiday, go out for a birthday dinner or splash out on a Christmas present – will be made around the country as households look at their budgets and gauge whether they can absorb hundreds or thousands of dollars in extra payments on their mortgage. Collectively, those small decisions will send shock waves through the wider economy.
“When you think of people dumping their mortgage, defaulting – people will not do that,” says Dr Michael Rehm, a senior lecturer in property at the University. “People will literally eat rice and beans … and cut out all the lovelinesses of life, and they’ll pay the mortgage.”
The sectors set to feel the pain are the service industry, tourism, hospitality and small businesses – many of the same sectors that suffered most during the pandemic.
“That is horrible for the economy – because so much money is being sucked out of the economy, and it’s been redirected towards paying interest, which in this country goes to foreign banks, largely,” Rehm says.
It’s this phenomenon that places housing shocks as a particular threat to the wider economy. Economists at the University of California have argued that credit-financed housing price bubbles are the most dangerous type of bubble for triggering a financial crisis. Another study found, “consumption falls by between five and seven cents for every dollar fall in housing net wealth”.
‘Just cool the jets’
In New Zealand’s case, a limited, or “shallow” recession is exactly what the Reserve Bank (RBNZ) is aiming for. “Think harder about your spending. Think about saving rather than consuming, I know that’s a strange concept,” Reserve Bank governor Adrian Orr said on Wednesday. “Just cool the jets.”
But reducing household spending is a blunt instrument to reign in inflation, and bank economists say it is laying the path for a bleak and rocky year ahead.
“Make no mistake, the RBNZ is not just signalling a recession, it’s forecasting a downturn on a similar scale to the global financial crisis – different causes, but similar consequences,” said Michael Gordon, Westpac Bank’s acting chief economist. “For the first time in a while, we’re also thinking about the risk that the RBNZ could end up overcooking it on the inflation front.”
New Zealand’s house prices began dropping sharply this year. In Auckland, the country’s largest city, median prices last month dropped 12.7% year on year while the rest of the country fell 7.5%.
Investors in housing will be feeling the heat of a number of policy interventions on top of rising interest rates: a tax on capital gains on properties bought and sold within 10 years, and the loss of interest deductibility on their tax bills.
The next question, Rehm says, is “if we’re gonna see those investors finally just say OK, to heck with it, sell whatever price it gets – then you should really see a collapsing of house prices, a collapse in the market.”
With the majority of New Zealand’s total wealth – more than 57% – tied up in housing, that could also mean the evaporation of many households’ primary assets.
“So much debt is held by households in this country, by owner-occupiers and investors,” Rehm says. So much wealth will be … evaporated if there was a collapse in house prices.”
