Low interest rates are shoring up house prices that might otherwise be deemed unaffordable, a Bank of New Zealand economist says.

BNZ senior economist Craig Ebert said although many big forces were colliding in the housing market, the lowest mortgage rates in a generation were having a bigger effect than many people realised.

With many wondering how people could afford what seemed like stratospheric house prices, Ebert said interest rates were "the missing piece on the puzzle".

They weren't the dominant or only factor but "in putting all their focus on those [other] issues, people have lost sight of one of the very basic drivers of the market which comes down to interest rates".

People underestimated the big effect that small changes in already low interest rates could have on their purchasing power, Ebert said.

"Normally people think a small change in mortgage rates shouldn't have that big effect. If interest rates move from, say, 10 per cent to 9 per cent, the effect isn't that big, but if they move from 5 per cent to 4 per cent the purchasing power effect becomes quite powerful."

He gave the example of a person paying $600 a week for accommodation who, under certain circumstances, might be able to bid up to $780,000 for a house when mortgage rates were 5 per cent.

But that dropped to $557,000 if interest rates jumped to 7 per cent - a near-30 per cent drop in purchasing power "for what would appear to be a moderate rise in mortgage rates".

Of course, he said, the person would have to have a 20 per cent deposit, and just because a mortgage calculator said they could service that level of mortgage did not mean they should.

"These things are affordable so long as interest rates stay this low, but the question is what if they don't stay this low?"

Having said that, there was a school of thought that these interest rates "are the new normal," which would keep house prices high.

Ebert said few people would criticise low interest rates because it was good for existing homeowners and investors and for businesses reliant on strong housing markets.

But they were masking what might have otherwise occurred in the housing market, he said.

New Zealand had managed to avoid a major house correction during the global financial crisis, due in large part to a big slash in interest rates, and now they were stoking the flames in areas of shortage and minimising price falls in regions which were stagnating".

With the economy going well, however, it seemed that overcooked house prices were "the rat we have had to swallow in order to support the broader economy".

"The default position appears to be that, so long as house price inflation slows, even goes flat, then we can grow into these over-sized house prices."

Source: Stuff.co.nz