Failure of banks doing stress tests

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Forums › Finance and wealth management › Failure of banks doing stress tests

Eitsop

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#303232 26-Jan-2023 10:28

I just seen this article in NZ Herald, and I immediately ask, did the bank do stress test on this loan? or was this loan done befor the more stringent measures put in place?

Either way the bank should have said no, if they couldn't afford interest at this level

https://www.nzherald.co.nz/nz/brings-tears-to-my-eyes-family-consider-selling-after-2500-monthly-interest-rate-rise/LGT6FRARRZAELKHDWVHJJYDIHE/

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#3027396 26-Jan-2023 10:35

Yes they stress test. From memory it used to be 8%. Could have been lowered. But pretty brave of the customer to fix for one year on million dollar loan.

I mean surely any home owner must ask themselves, historically the average interest rate has been 8%. Can I afford the repayments on that?

It also doesn't mention the customer's income either so we don't know how much they're paying as a portion. Stress testing shouldn't mean two minute noodles but we need more numbers.

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#3027397 26-Jan-2023 10:37

Yes, but the family must also take responsibility for their own stress tests. Ultimately they should have said no.

nzkc

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#3027402 26-Jan-2023 10:41

There's a lot of info that is not in that article that would be relevant to the banks decision. What is their level of income? How much savings did they have? What other assets do they have (maybe they have properties elsewhere)? What other purchases, particularly loan bearing ones, have they made? Why didnt they take out a longer (5yr) term loan especially if they are now campaigning for 30yr mortgages like the US (FWIW I think we should have options for longer term loans)

For the savings, there'd be an easy assumption based on the loan amount and property price. Might not be that figure of approx $200K at all though.

I have mixed feelings about the current situation and people like this couple are now in. Its really tough for them and I feel for them. I also see there being some sense of responsibility and sense on their part needed to work out "what level of interest can we afford". Because historically our rates have been far higher than when they borrowed.

tchart

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#3027404 26-Jan-2023 10:44

I do feel for them and yes the bank would have stressed tested this but neither party probably realised how much interest rates would rise.

I was in this situation when I bought our first place - this was just before the GFC. I had to change jobs to get a pay bump to see us through that - single income with kids and all that.

As a first time home buyer I was treated pretty badly by the banks eg my bank of 10+ years wouldnt give us a look in, the bank we went with wouldnt budge on rates come renewal time, penal rates for <20% equity etc. Being a first time home buyer sucks big time.

There are alternatives such as interest only that they should consider first. They could fix for 2 years and do interest only for around ~$5000 and ride it out. Yes its sucks but given they have just started a 30 year term its not a big deal TBH.

I dont know the market in Nelson but I dont think any first time buyer should be spending $1.2 million on a home. The figure of $6700 per month means you would need to be earning at least $120K just to cover the mortgage.

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#3027409 26-Jan-2023 10:59

I do struggle to sympathise in these scenarios. The family took out a $1.0Mn loan on a $1.2Mn property as first homes buyers in a city with a median house price of $699k.

There are just so many quotes in this article that point out how naive the family are. Its known fact that in the early years of a mortgage that most of your repayments go towards interest and little of it goes towards paying down capital. That's how mortgages work.

I also wouldn't put the US banking system on a pedestal as a symbol of how it should be!

Earbanean

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#3027411 26-Jan-2023 11:08

Banks definitely stress test. However, those tests still require a reasonable amount of honesty in terms of expenses and income. Some of those numbers, like current income, must be proven, but a lot still require accurate and honest data to be provided in applications. I'm not saying in that particular case they lied about anything, but sometimes people do and also sometimes people have unrealistic expectations about future expenses, income etc.

Going forward there are new initiatives coming in around open banking. Under this, the banks will share transactional data so one bank can check levels of expenditure etc through cards and accounts at other banks. That will help with accuracy in lending decisions.

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richms

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#3027425 26-Jan-2023 11:13

Also comparing the rise on their payments with the inflation rate seems that they dont understand that they are 2 totally different things and dont get compared.

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duckDecoy

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#3027428 26-Jan-2023 11:30

Without wanting to pile onto the Nelson family specifically, I am still amazed at how many people we know who would always chase the lower rates and lock in for very short periods of time, rather than signing on for longer term rates that lock in payment security. A few of our friends had proper brown underwear moments when their short term gambles rolled off and they were left with rates much higher than they could really afford. Different strokes I guess.

But had it been me (and without knowing anything about the Nelson family's situation) I would not have rolled the dice on a $1million mortgage, i'd have locked in for as long as I could.

GV27

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#3027430 26-Jan-2023 11:33

Earbanean:

Banks definitely stress test. However, those tests still require a reasonable amount of honesty in terms of expenses and income. Some of those numbers, like current income, must be proven, but a lot still require accurate and honest data to be provided in applications. I'm not saying in that particular case they lied about anything, but sometimes people do and also sometimes people have unrealistic expectations about future expenses, income etc.

As recently as May of 2022, the stress tests were being done at 6.85%.

https://www.stuff.co.nz/business/128522319/asb-becomes-second-bank-this-week-to-increases-home-loan-stress-test

I don't think it's reasonable to expect new homebuyers to factor in the fastest period of rates increases in history as a possibility when assessing their own finances when the banks have apparently had the same issue, what with them having the resources and knowledge that comes with multi-billion dollar retail banking operations, vs your average person off the street.

The real question is the mechanics of a stress test. Yes, the rates on the mortgage go up, but what if food, daycare costs, travel and your insurances also go up by 10% or more. Do these stress tests capture the extent of the type of economic circumstance in which you would see sudden interest rate rises, or do they just measure the bit the banks are interested? I don't know, but I would be keen to find out.

There are now going to be a bunch of people re-fixing initially low fixed term loans rolling off at rates far above what they were stress-tested at.

GV27

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#3027431 26-Jan-2023 11:36

duckDecoy:

Without wanting to pile onto the Nelson family specifically, I am still amazed at how many people we know who would always chase the lower rates and lock in for very short periods of time, rather than signing on for longer term rates that lock in payment security. A few of our friends had proper brown underwear moments when their short term gambles rolled off and they were left with rates much higher than they could really afford. Different strokes I guess.

I rolled the dice on a portion of our mortgage because I naively believed RBNZ's commentary that banks should prepare for negative interest rates and that they couldn't see them increasing very fast.

You can call me unlucky, but you can't say I didn't make a reasonable decision based on information that has been proven to be utterly incorrect, through no fault of my own. So I can understand people who made the mistake of trying to make an informed decision based on the commentary of the people literally pulling the levers on this kind of thing.

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#3027435 26-Jan-2023 11:43

The article is completely unbalanced and reads like a beat up on banks. I can appreciate that such an increase in rates may not have been expected, but "experts" in the media have been very vocal for a long time about the low rates and that they weren't sustainable long term. For someone to commit to a 12 month fixed term among fairly obvious publicity about the volatility and direction of interest rates seems naive at best.

I can't comprehend needing to borrow at the levels people now "have to" in order to buy a house, but in this instance, it would seem the borrower has virtually no understanding about how loans work, and was so keen to buy a house that caution was thrown to the wind, this time its come back in his face which is unfortunate.

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cddt

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#3027436 26-Jan-2023 11:46

nzherald:

One thing Aaron hoped could be imported from his native United States was 30-year fixed rate home loans.

The US government underwrites these loans and wears the risk of interest rate fluctuations. NZ can't afford to do this (although we used to through the State Advances Corporation).

This family's first mistake was not fixing long or at least hedging through splitting their loan into tranches. They should have taken the $1m and split it into five tranches, weighted on how they thought interest rates would change, but instead they put all their eggs in the 1-year bucket. In 2021 there was little room for downward rate movement so little benefit to fixing short...

I always recommend splitting your loan into at least two or three tranches so any changes in interest rates only impact a small portion of your loan at a time.

wellygary

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#3027437 26-Jan-2023 11:47

mudguard:
It also doesn't mention the customer's income either so we don't know how much they're paying as a portion. Stress testing shouldn't mean two minute noodles but we need more numbers.

Yeah, need both sides of the equation to see if this is the result of a change in circumstances or that the bank should have not granted them a mortgage in the first place,

But I found the whinge at the end about 30 year mortgages a bit much....

This guy only fixed his for a year, and when it came up he again fixed at the short end.. (I guess because it was cheaper)... but really if you want some form of "insurance" you end up paying a higher rate to fix for longer...

in 2020 there were 5 years rates around 4.3%...

cddt

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#3027439 26-Jan-2023 11:49

GV27:

As recently as May of 2022, the stress tests were being done at 6.85%.

The lowest stress test any of the banks are on record as admitting to using in 2021 was 5.8%, and apparently that was only for a short period of time and so a small number of borrowers.

MikeAqua

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#3027442 26-Jan-2023 12:00

I know that house. It's a really nice house that was subject of some major looking renovations a few years ago. I used to walk past it every day on my way to work.

I've personally found that when banks have told me how much we could borrow (based on income, outgoings etc) it was horrifying amount. The banks have been comfortable lending 50% more than I'm comfortable borrowing.

We've been really conscious of the historic low interest rates we have had for the last few years and pushed ourselves to repay them hard. Lockdown helped us. I even went to the extent of taking a sabbatical from my usual job to do a few fishing trips and save the extra income for when the mortgages come off fixed.

I feel we are as prepared for what's coming as we can be.

Mike

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