Interest rates are looking stable, but there’s another more sinister risk looming…

A friend of mine came home the other day and attempted to park in his garage. The garage door was going up-down, up-down by itself. It was spooky. Turned out the remote was in the pocket of his jeans, spinning round-and-round in the washing machine somewhere in the house. Operating the door without his control.

First World problems, I know…but this is how a lot of people feel about debt, especially mortgage debt. It only takes one thing to go wrong and it can spiral out of control.


Where are interest rates heading?

On this front, we’re looking good. Reserve Bank Governor Adrian Orr indicated that he does not expect the next OCR move to be until 2020. There’re no big price increases on the horizon — inflation projections are looking steady. And the Kiwi dollar is sitting at a relative soft point against the greenback. So, in terms of rates, the ship should be steady.


Still waters run deep…

Walmart Corporate

Source: Dickxon Fernando |

There could be more to this than meets the eye. It’s rare for a central bank to keep rates at historic lows in the long run. Especially when an economy is humming and rents are rising.

Read beyond the lines. Adrian Orr is worried about mortgage debt and where the housing market could go. Following a financial stability report last year, which put the income-to-debt ratio for mortgage holders at 350%, he told Newshub, ‘Where people have five times their income leveraged in these mortgages, you’re saying, “That is just too high.”’ And he asked the question, ‘Why are banks lending at such an extreme level?

Check out a range of personal finance blogs around the net. They all suggest household debt shouldn’t exceed 2.5 times income.


So I’m covering my mortgage — what’s the danger?

Danger One:

The value of your home takes a hit, and your equity tumbles. There’s plenty of evidence that Kiwi house prices have been too high and that foreign buyers played a bigger role than we thought. Auckland house sales were down 20% last month. And tenancy and tax changes, along with new supply, are starting to impact. When sales volumes get shaky, prices tend to follow.

A decline in your equity changes your LVR (loan-to-value ratio). And that impacts on your ability to get more credit and potentially your terms with the bank when things come up for renewal.

Danger Two:

Life happens. A mortgage broker friend shared a story with me the other day. A client earning $200,000 lost his job and needed money to support his family. He went to his bank and asked to drawdown on his mortgage to tide him over. He had equity in his home of around $600,000 with a low LVR.

The bank said no. I was shocked. Surely, with that much equity, the risk was minimal? Under responsible lending restrictions, bank borrowing must be supported by income.

So what was the outcome? The mortgage broker managed to connect him to a non-bank lender at 9%!


The looming debt bomb

If there’s a crash in the property market — I’m talking 20% plus — we’re in trouble. Coupled with a recession tipped by the global economy, it would be nuclear. And there’s plenty of risks circling from a bad Brexit to a flashpoint between China and the US.

Simply put, if values fall that thick and fast, it’ll start to break the rest of the economy and threaten people’s jobs. Businesses tied to property will be the first to wobble. Then you’ve got a financial crisis sort of situation where a lot more people can’t afford their debt.

Unfortunately, like many Western economies, we bought into the free-trade, globalisation Kool-Aid decades ago. Cheap goods and easy credit sucked us in. Jobs that created real things moved offshore. And now goods ship across vast distances, spewing carbon.

We’re now a ‘service-based’ and ‘financialised’ economy. Read — we work by serving each other, the job market is a whole lot more uncertain, real wages have barely moved. And we appear wealthy via the drug of easy credit and over-leveraged homes.

The trouble with service-based economies is there’s not enough investment focus on production.

When a factory owner sees things about to improve, he ramps things up in advance to start filling the warehouse. Maybe he needs some investment into a new plant and more workers.

A barber, on the other hand, won’t employ more cutters until he sees more dudes waiting for a haircut. Likewise, lawyers and accountants need to see more clients coming through with files before they take on more staff.

Meanwhile, investment and lending try to find a home in the economy — and without enough productive businesses — they find housing and start feeding off each other.

One way to keep the merry-go-round going is to turn the foreign money tap back on. Unsustainably high immigration is one lever previous governments seem to have used. The trouble with that is that young New Zealanders, often carrying student debt and trying to get into their first home, end up competing in the property market with hot cash trying to exit more crowded and polluted areas of the world — where they’ve been making everything.

And so we continue to push people to take on hazardous levels of debt.


So what can be done?

According to the mainstream media, we’re meant to be surprised by populist wins for Brexit and Trump. I say consider the wisdom of crowds. People want the opportunity to control their destiny, control their borders and produce more of the goods they use. They want to be in a position of surplus, not deficit and decline.

As households, we can take the same approach. We can look at how we spend, borrow, save, and invest. We can consider the productivity and the sustainability of what we’re doing with our money. And as a starting point, that comes down to learning about the power of investment.

Stick with us at Money Morning. We’ve got a whole lot more to show you…


Simon Angelo
Analyst, Money Morning New Zealand