Mark Lister, July 2022

When it comes to our attitude to debt, there are two distinct schools of thought in New Zealand.

We have the younger people, who are quite comfortable borrowing a lot, and the slightly older generation, who are much more conservative.

Both groups have been shaped by their experiences.

During the 1970s and 1980s, the New Zealand inflation rate averaged 11.4 per cent. This was extremely high, and it ensured a sharp rise in interest rates as a result.

The floating mortgage rate was about 6-7 per cent in the early 1970s, but it moved progressively higher and peaked at more than 20 per cent in 1987. On average, mortgage rates were 13.0 per cent during those two decades.

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Having faced a such a consistent, steady increase over that period, culminating in such a high cost of borrowing, it's no surprise many New Zealanders are no fan of high debt levels or being beholden to the bank.

Then came the low inflation era, which brought lower borrowing costs with it.

There were several structural drivers of this trend, including technological advances, globalisation, the emergence of China as a low-cost producer and the advent of inflation targeting by the world's central banks (which our own Reserve Bank pioneered).

Since 1990, New Zealand inflation has averaged 2.2 per cent.

That saw interest rates consistently decline from the highs of the late 1980s to the very low levels we’ve become accustomed to in recent years.

The floating mortgage rate was 14.8 per cent at the beginning of 1990, and it fell to 4.4 per cent this time last year, the lowest we’ve seen in Reserve Bank data going back to 1964. Fixed rates have been lower still in recent years, at closer to two per cent.

To put that into perspective, anyone under 50 years old has spent their entire adult life watching interest rates fall, against a backdrop of very low inflation.

Their world view has been shaped by rising asset prices and falling borrowing costs, which is a great combination for using leverage to create wealth.

New Zealand house prices have risen an impressive 6.7 per cent annually since 1990, although it’s the impact of leverage that has made the biggest difference.

In financial terms, this means using borrowed money to invest in something. In a rising market it works extremely well, supercharging returns and leading to the strong gains many homeowners have enjoyed in recent years.

However, it comes with a catch. In a flat or falling market leverage can do the opposite, by magnifying your losses.

Rising borrowing costs can add insult to injury, and in extreme cases highly indebted borrowers can find themselves forced sellers during weak markets.

Those around in the 1970s and 1980s will recall what can happen when people (or businesses) bite off more than they can chew. They have long memories, and this has left many with an ingrained aversion to debt.

Both cohorts are correct in their thinking and as with most things, the truth is somewhere in the middle.

Debt can be a great tool if used wisely, and people need to be prepared to take some risks to build their wealth. However, investors can also end up on the wrong side of the equation if they borrow heavily at the wrong part of the cycle.