5.5 Susceptibility of those with high debt servicing obligations to unexpected shocks

The survey data used in the analysis has been drawn from wave 2 of SoFIE and relates to the year ended September 2004. For the analysis in this section we have made adjustments to some of the income and wealth variables and altered relevant parameters (such as mortgage interest rates) in line with observed changes in macroeconomic conditions between the year ended September 2004 and June 2008.[59] In the absence of survey data for 2008, this approach provided a dataset from which the extent of debt problems in 2008 could be estimated.[60]

Our adjustment to earnings assumed an underlying earnings growth of 17%.[61] However, it is recognised that not all individuals will have had a growth in earnings equal to the average amount. Rather, there will be a distribution about that average. To reflect this we introduced a random shock to our estimate of each individual's permanent income.[62] While this is an important adjustment, it is possible that different types of people may be more or less likely to have experienced positive growth in earnings over the period. If the factors explaining changes in income since 2003/04 are also correlated with debt levels, then our adjusted estimates of the proportion of families in the “problem debt” and “at risk” categories may be biased.

We also allowed for the fact that house prices, mortgage levels and mortgage interest rates had changed between 2004 and 2008. However, we applied the same scale factors to all families. If the characteristics and relative debt levels of those who have taken out mortgages recently differ from mortgage holders in 2003/04, our estimates of the proportion at risk may be affected. For instance, although the aggregate gearing ratio for housing remained steady between 2003 and 2007, there is anecdotal evidence that, in some cases, banks were willing to lend at higher loan to value ratios over that period than in the past. Therefore our 2008 estimates may understate the number of families in the at risk category. Given the limitations of our adjustments to income and wealth, our estimates for 2008 might best be regarded as lower bounds.

Table 19 compares the baseline estimates for 2008 with estimates that apply to 2003/04. In the first instance, the estimate of the proportion with negative net wealth is little changed from 2003/04. For both non-partnered individuals and couples, the proportions facing debt servicing costs in excess of 30% or 40% of gross income are estimated to have doubled. This is the effect of higher mortgage interest rates and higher house prices that are likely to have led to more borrowing at higher rates.

The observed 2003/04 data is based on a year ending September year, while the estimated results for 2008 are for a June year.

Sources: SoFIE wave 2, Statistics New Zealand; the Treasury

For non-partnered individuals there was little or no change in the percentage of those with debt who were deemed to be at risk (ie, paying more than 30% of their income in debt servicing and simultaneously having negative net wealth). However, for couples, the estimate of the percentage with negative net wealth and paying more than 30% of their incomes rose from 0.8% to 1.1%; or based on the numbers in 2003/04, we estimate that the number of couples at risk increased from about 6,000 to 8,000.

Table 20 summarises the results of varying mortgage rates and income on the estimate of the percentage of family units with debt who had high debt servicing costs and the percentage deemed to be at risk. A reduction in mortgage interest rates of 2 percentage points reduces the estimate of the number at risk by about 5% or 1,000 families. If this were to occur together with a 10% increase in incomes, our results indicate that the number of families at risk could fall by about 12% or 2,300. Note that 2,300 families represent less than half a percent of the number of families with debt.

Sources: SoFIE wave 2, Statistics New Zealand; the Treasury

We have also estimated the possible impact of a fall in house prices holding other factors fixed (see Table 21). In a scenario where average nominal house prices fall 20% from their level in June 2008, our estimate of the percentage of couples with debt who have negative net wealth increases from 8.3% to 9.7%. As negative net wealth is not necessarily a cause for concern if the family can continue to meet its debt servicing obligations, we also estimate the effect on the percentage deemed to be most at risk (ie, having negative net wealth and paying more than 30% of income in debt servicing). Our estimate of the percentage deemed at risk increases from 1.1% to 1.9%, corresponding to approximately 5,000 families. In the same scenario, our estimate of the percentage of non-partnered individuals with debt deemed to be at risk increases from 1.8% to 2.6%, corresponding to about 5,000 non-partnered individuals.

While these estimates allow for random shocks to income between 2003/04 and 2008, they assume that incomes remain at levels estimated for 2008. Mortgage interest rates are also held fixed. At the time of writing, most economists were forecasting an increase in the rate of unemployment over the next two years and this would be expected to increase the number of families facing negative income shocks.[63] If the affected families include some of those with negative wealth whose debt servicing costs are pushed over the problem debt threshold of 30% of their income, this would increase the percentage at risk. On the other hand, any reduction in interest rates would reduce debt servicing costs and would be expected to reduce the percentage at risk. These effects partially offset.

However, these estimates do not allow for the possibility that new entrants into the housing market may have higher gearing ratios than we observe in the 2003/04 data, making them potentially more vulnerable to house price falls. As such, a fall in house prices may result in a larger increase in the number of families at risk than our results suggest.

Sources: SoFIE wave 2, Statistics New Zealand; the Treasury