The Reserve Bank has reported the risks in the financial system have reduced in the last six months, but warns that house prices remain overvalued in many parts of the country and the most indebted borrowers remain vulnerable to a correction and a sharp rise in interest rates.
The bank reiterated that it was pushing ahead with a consultation to include a Debt to Income (DTI) multiple restriction in its toolkit of Macro-Prudential controls to improve the financial stability of banks. It reported in its half yearly financial stability report that it would not use the tool if it had it at the moment.
"However, demand drivers in the housing market remain strong, and a resurgence of house prices remains possible," the bank said in the report. It also noted that housing supply was not keeping up with population growth.
"Should high house price growth return and the proportion of housing lending at high DTI ratio remains high, a DTI restriction could be warranted," it said.
The Reserve Bank did not specify what threshold it would use, but it again highlighted that more than 50 percent of landlords were still being lent more than five times their incomes, although this had fallen from 58 percent a year ago because of the new 40 percent deposit requirement introduced by the bank.
The bank also included a special section (Box A on page 28) on the vulnerability of highly indebted owner-occupiers to a sharp rise in interest rates. It estimated that seven percent of all borrowers and 18 percent of recent borrowers would face severe stress in being able to make their mortgage payments if interest rates rose to nine percent. It said recent Auckland borrowers faced even higher stress.
The bank also noted that borrowers with high DTI ratios were the most vulnerable to rising mortgage rates.
"At a mortgage rate of seven percent, around half of existing borrowers with DTI ratios above five are expected to face severe stress," it said.
The bank summarised by saying the analysis showed a significant proportion of borrowers were vulnerable to higher interest rates.
"A sharp and unexpected rise in mortgage rates could see the most vulnerable households default, sell their houses or reduce consumption to repay debt," it said.
Recent borrowers in Auckland and borrowers with high DTI ratios appear most vulnerable, signalling that a continued high share of lending at high DTI ratios is concerning and may present a risk to the housing market and financial stability."