Recently, test rates have received a lot of attention as major lenders respond to a volatile market with a rise to over 7% (at the time of publishing). In this blog, NZHL (New Zealand Home Loans) Lending Lead, Lea Corfield looks at the role of test rates in responsible lending and how they impact borrowers.
What is a test rate?
A test rate is a hypothetical rate used by lenders to determine affordability when assessing home loan applications. Exact methodologies differ, depending on the lender. However, test rates essentially ‘stress test’ your (short-medium term) ability to pay your loan in a rising interest rate environment as we are currently experiencing.
It’s important to note test rates are fluid – increasing or decreasing with market conditions.
So, depending on the current market, when refixing their loan, borrowers may pay a higher interest rate than the rate they were tested with at the time of purchasing.
With record low-interest rates in recent years, this is ringing true for some borrowers experiencing the impact of higher interest rates.
If this is you, you may be wondering – what does this mean for me?
While some homeowners may rightfully be concerned, qualified Financial Advisors (at NZHL we call them Mortgage Mentors) can proactively work with you to determine the impact and next steps to help you transition to higher rates.
While you can’t control the rates, you can tailor a home loan structure that best fits your situation and makes the most of your money to reduce your interest costs, over the life of your loan.
If you’re facing a shift to higher interest rates or want to ensure your structure is still fit for purpose, now is the time to get in touch with your local Mortgage Mentor.
Or, if cash flow is tight and you’re finding it difficult to pay your loan, your Mortgage Mentor can discuss your options. There are several ways to overcome this, such as altering payments, adopting a portfolio approach, or applying for hardship assistance if appropriate.
However, it’s crucial to get advice tailored to your specific situation as changes to your loan may extend your home loan term and, in turn, your long-term total interest costs.
If you’re managing to make your home loan repayments, the review process is still critical to ensuring your home loan structure is supporting your ability to achieve your financial goals.
As test and interest rates change, there will likely also be times when the interest rates you pay are lower than your initial test rate.
When this happens, it’s your opportunity to make headway into reducing your debt (and therefore interest costs) if you’re able to keep your repayments to the higher test rate. Remember, even a little extra goes a long way to reduce the interest you pay over the life of your loan.
Because of this, at NZHL, we believe regular reviews are crucial to ensuring your home loan structure is working best for you, particularly in this challenging environment. Life can change quickly, and time is money when it comes to your home loan.
So, rather than a ‘set and forget’ approach, we encourage active monitoring and coaching with your Mortgage Mentor to ensure you’re making the most of the money available to you and, if circumstances change your plan is updated quickly.
Test rates and purchasing
If you’re in the market to purchase, a higher test rate will likely impact the affordability of your loan and the maximum amount you can borrow. While this will impact all home loan applications, homeowners looking to refinance or purchase a new house may find they can’t borrow as much as they have previously.
While this may cause frustration, test rates are a key part of ensuring responsible lending to (as much as possible) prevent borrowers from taking out a loan that could potentially cause financial stress.
Talk to your local Mortgage Mentor sooner rather than later. It’s never too early to determine what’s needed to put you in a good position to purchase.
*Please note – Lea Corfield is a lending lead at NZHL and has written this blog based on her experience. This blog is intended to be general in nature and should not replace personalised financial advice by your mortgage adviser.
