Are you ready to beat the Test Rate?

Now you see the house prices dropped, and you see the opportunity to buy at a lower price than 2 years ago, you start thinking about renting out your current property and buying a new property to live, you go onto the online mortgage calculators, put down the current interest rates and work out you could borrow $X amount. You reach out to one of our advisers and talk about your plan, only to find out later that you were unable to borrow the amount you wanted due to affordability, and there is disappointment to come. How often does that happen? A lot, but why?

Affordability is a big topic in today's environment. A bank agrees to lend you money because you can show your ability to repay. Many of you would put in today's interest rate say 6.95% to work out your maximum affordable loan amount. While affordability looks at many different aspect, such as incomes, living expenses, discretional expenses, one of the critical fixed expenses is the potential mortgage repayment amount. Banks use test rate to assess borrowers' capacity to meet repayment requirements. Multiple banks have just increased their test rates this week, and the average test rate is about 9%.

ASB said "test rates are set to ensure customers have room in their current budget to make larger repayments if interest rates rise. We consider a range of factors when setting a test rate, including current and forecast economic conditions, current home loan interest rates, and how interest rates may change across a longer time-period or economic cycle."

During the Covid year we saw the historic low mortgage interest rates at 2.19%, and the test rate at the time was about 5.85%, comparing to almost 9% now. If someone wanted to borrow $500,000 back in 2020, the tested repayment amount was $2,950 per month; while today at 9% test rate clients needed to show ability to repay $4,024 per month. The challenge starts stacking up if we also increase the benchmark living expenses due to high cost of living.

One could argue the current test rate is too high. If we looked at someone who took a mortgage in 2020, their actual mortgage interest rate was around 2.19% for 1 year, and they are now paying 6.99% for 1 year. They were only tested to service the mortgage at 5.85%. Some mortgage holders have to adjust their spending habit and look for ways to top up the mortgage repayment. You must remember that you should always carry out own risk assessment when making these important decision, such as buying a property, generally it is a long term investment, and you should consider wider and longer term situation change. I still remember a client personally used 10.5% for own assessment when the bank was only using 7.25%. And that's his comfortable level.

Our SuperCity Mortgages advisers can work with you and provide valuable advices along the way. Reach out to one of us if you have more questions around affordability or want to secure a pre-approval for your next property.

The opinions expressed in this article should not be taken as financial advice, or a recommendation of any financial product. SuperCity Mortgages & Insurance shall not be liable or responsible for any information, omissions, or errors present. Any commentary provided are the personal views of the author and are not necessarily representative of the views and opinions of SuperCity Mortgages & Insurance. We recommend seeking professional legal and/or mortgage advice before taking any action. Our Disclosure Statements are available on our?website.