By Stephen Hickson*
It feels like a perfect storm is building. The rising cost of living and higher interest rates are putting household budgets under stress, and falling house prices could push some home owners into negative equity.
On the one hand, the drop in house prices is a good thing as it makes housing more affordable, particularly for young people – and we want that.
But every transaction has two sides. Dropping house prices are bad for those who need or want to sell their house, or who hold most of their wealth in their home. These people are now markedly poorer.
In September 2017, the average house in New Zealand cost NZ$666,518. By January 2022, prices had peaked at $1,063,765. But by September 2022, the average house price had slipped to $956,592. The downward trend may continue for a while yet.
Some 32% of New Zealand households have a mortgage on the primary residence, with the median property debt increasing to $260,000 in the year ended June 2021, up $56,000 over the past three years.
A looming threat
For most home owners, a small or even moderate fall in the value of their home won’t make any practical difference. Their house will still probably be worth more now than it was two years ago and it will still be worth more than their mortgage.
However, for those whose mortgage is a high fraction of the value of their home – those who bought property in 2021 when rates were low and house prices high, for example – the risk is that they will fall into negative equity.
A borrower enters negative equity if the value of their home drops below the value of their mortgage.
For around 2% of New Zealand mortgage holders, this threat has become a reality.
But is it time to panic? Well, probably not. As long as you don’t need to sell your house and you can sustain your mortgage payments, then negative equity doesn’t matter all that much. You can just wait it out.
That said, negative equity can become more of an issue when other economic issues – rising inflation, unemployment or interest rates – rear their heads.
Contributing risk factors
Lets start with interest rates. Rising interest rates are making debt more expensive. Local media are already publishing stories of white collar workers struggling to pay their mortgages.
Yes, interest rates are rising but they are still relatively low. The floating rate for a first mortgage is currently 6.8%. Prior to the 2008 global financial crisis (GFC), this interest rate tier hit a peak of 10.9%.
“We did take out the mortgage knowing rates would fluctuate, and budgeted for that, but there is always a point where it becomes too much.”
— Nicole Friedman (@NicoleFriedman) November 7, 2022
Home prices could drop sharply in Australia, Canada and New Zealand as interest-rates rise https://t.co/2h2cQwR3lr by @JamesGlynnWSJ
That said, interest rates fell over the course of the GFC, while rates are currently rising. Furthermore, the level of debt held by many households is now higher since people had to take on bigger mortgages as house prices rose. Bigger debt levels makes higher interest rates harder to cope with.
Unemployment will make negative equity a bigger issue. Currently, New Zealand’s unemployment rate is historically low, meaning most people with a mortgage can feel relatively secure in their job or job prospects.
But it won’t stay there.
The low unemployment makes it harder for the Reserve Bank of New Zealand (RBNZ) to rein in inflation, particularly if wages continue to rise. The RBNZ has been clear that New Zealand needs to get ready for a rise in unemployment, with some economists saying 50,000 New Zealanders would need to lose their jobs to bring inflation under control.
Rises in both unemployment and interest rates at the same time will increase the chance that some highly-leveraged mortgage holders get into problems.
Did we learn from the GFC?
Negative equity was a big problem during the 2008 GFC as house prices fell and banks accumulated bad loans. This issue hit the United States and parts of Europe particularly hard.
But that doesn’t mean we are heading to the same place now.
Following the 2008 crisis, New Zealand’s lending rules changed, requiring banks to be more cautious when lending. In 2021, these rules were refined even further. The number of low-equity loans that banks could make was reduced and banks had to look more closely at a borrower’s ability to repay debt.
Some of these requirements have certainly made it harder for first home buyers, perhaps overly so, but it has reduced the risk in our financial system.
This time around there will be fewer borrowers with mortgages that are a high fraction of the value of their house and fewer who can’t manage higher mortgage repayments.
Banks also have no incentive to push people into a default on their mortgage. This is especially true when there is negative equity. The bank doesn’t win if they force the sale of a home and get back less than they were owed. And the headline “Bank evicts mum with two toddlers” never plays well.
So expect banks to work hard with any struggling mortgage holders to help them keep paying the mortgage.
Feel like we're about to have a bunch more "banks are making huge profits because they're GREEDY" takes and I would like to remind everyone that banks have always been greedy and were not in fact running a charity until now
— Emma Vitz (@EmmaVitz) November 7, 2022
The immediate future is not going to be pleasant for many borrowers. The RBNZ must get inflation down. Doing that will not be easy and homeowners should prepare for higher interest rates.
But negative equity is not a problem providing you don’t need to sell your house and you can afford to pay your mortgage.
Even if unemployment rises to 7%, which is just above the post GFC peak, that would still mean a 93% employment rate. Most people will be in work, living in their house and paying their mortgage – even those with negative equity.
*Stephen Hickson, Economics Lecturer and Director Business Taught Masters Programme, University of Canterbury
This article is republished from The Conversation under a Creative Commons license. Read the original article.
62 Comments
Agreed.
Those that "have" to sell are going to get punished. If the Govt continues to soft foot around interest rates/asset price balance, this will drag on well after the smug speculators five year 2.99% fixed rates expire. Then it will be a very possible 10% environment. FOOP cleanup time.
The kaaarrrrkkkk moment is approaching.
I was at a bbq the other day - anecdote alert - and I was talking to a young couple who are about to refinance. They said things will become very tight for them but they will get by. However they said they know a few couples who bought in the last 2 years who will simply have to sell.
Fewchur. In the scrolls, Tomorrow shalt be referred to as today.
It has been said that the disciples of the prophet are abandoning the faith and turning to other religions. The golden glow of alternative faiths is proving alluring to all but the fanatical followers.
... negative equity doesn’t matter all that much. You can just wait it out.
Of course, you could be waiting a very substantial portion of your lifetime, living in abject poverty, servicing your oversized mortgage, all for a lousy townhouse in a lousy suburb that no longer suits your needs. It all could have been very different if only you hadn't been fooled by the amateur and professional real-estate spruikers / con-artists that were whispering sweet lies in your ear.
There is light at the end of the tunnel, for one day you might again have a positive net worth. But you will have lost your youth. Wasted on saving up all that deposit and then clawing your way back to solvency just to end up with little more than grey hair.
How To Lose 4K Per Week.
Go to the Casino ? - Good Thinking but unfortunately there is still a chance you could Win more than you lose. So that's a Fail, much to Risky.
Go to the TAB ? - Drink some beers, have a laugh, hang out with ya mates. Still to Risky, people have been known to win more than 4K, that's a Fail. Not worth taking that kind of a Chance.
Throw it over the Bridge? - Another great idea, I would recommend it is done in the darkness of the night. But not wanting to sound like the bearer of bad news there are still honest people that would pick it up and return it to the police, and cameras or any witnesses could track the cash to be returned back to you. That's a Fail.
Buy a House in the Regions ? Now we are getting warm, this is a guaranteed way to lose 2-3K per week, it is tried and proven with institutions following the losses with a fine tooth comb. Sadly 2-3K is Not 4K. So that's also a Fail.
Buy a House in Auckland or Wellington ? - BINGO ! You are the Winner !
This is the most effective way to lose 4K Per Week without the risk of making more than you lose. No one will return your cash, no late night walks over bridges, no weirdos at the Casinos, no fights at the TAB, it's safe and secure and totally acceptable.
For the High Rollers out there wanting to lose big, we recommend the North Shore, it has already Crashed -28.6% with much much more losses to come.
Get on the Property Slide . Interest Rates are Going High for Long.
Serious question Future. I presume you are renting as you have nothing positive to say about buying a house so my question is how long are you going to wait ? Basically you have to put a number of it because you don't live forever. Reality is when you get get age 55 like me you realise it WAS a pretty small window of time to get that house paid off.
Old friends got to London in the 1970s, got married, got good work and ended up staying there which wasn’t actually the original plan. They bought a good sized stand alone town house south of London with a good sized section and handy to rail. They are still happily right there, retired, no mortgage. But during that time I recall there were at least two instances when house price crashes put them into negative equity. It didn’t matter they just stuck to their knitting, got two children through university, enjoyed life as always and came out well.As far as I can see a home is more important than a house.
... which is nice if you:
1) want to live in the same house your whole life, and
2) want to stay living with the same person your whole life, and
3) want to keep working to pay a mortgage your whole life, and
4) are happy to ignore opportunity cost and financial losses.
It sounds like a miserable existence to me. I'd want to rip my own eyes out with the boredom and banality and waste of it all. But it is probably a happy, ideal, existence for others. Each to their own.
This crayfish pot that the central bankers have led us into is not really traditional or orthodox or conventional though, is it?
For the ordinary couple today, owning a house means that both partners have to work full time, or nearly full time. Put the kids into daycare, then after-school care and holiday programs. Take on eye-watering amounts of debt. Live with the threat of negative equity. All for a house and situation that is inferior to your friends' nice standalone house with a garden near London.
The society that the central bankers and their debt machine have engineered is very different to any kind of society that previous generations experienced. It is different to the traditional kind of society, where dad works and mum stays at home, and blue collar workers can have a home of their own, paid off well before retirement.
I just see it as kind of an entrapment, a slavery, that previous generations did not endure.
It’s all relative to the generation of the time and circumstances that existed. Recall listening to Brian Edwards on RNZ interviewing a well known & regarded trade unionist. A large family, as young kids in the early 50s, they made sand soap & peddled it around households all over Auckland & offered to sharpen scissors at the same time. Hard to imagine what ambitions and aspirations they would have been able to set for themselves isn’t it.But yes today there are influences such as debt inducement & temptation, the poverty traps of old in new clothes, and it is no wonder that many are prioritising the ability as best able of having the security, the respite, of a home. As you say each to their own and in reality that looking after oneself and family first is I believe, out of necessity, becoming more and more prevalent.
Carlos67 - The Big Mistake you and others make is that you Assume that a Renter needs to borrow money to buy a house.
The Prophet has made it very clear that Interest Rates would go to 7% this year - Prophecy Confirmed.
Also The Prophet said - -30% Crash In Home Prices by December - North Shore is at -28.6% last month.
The Scroll said -
Interest Rates will continue to go Up from here and Stay Up for a Long Time.
Banks will sell Mortgages at 10% +. ( Double Digits ). The OCR Forecast Peak Goalposts will continually be Moved Higher and Higher ! 10% Interest Rates Next Year, Guaranteed !
The World will go into the Biggest Financial Crash Ever Recorded !
There will be many many examples here in NZ of Property that once sold for $1,000,000 Sell again at $200,000 or less. -80% Crash in Home Prices will be common. This will take time to play out.
So Carlos67 - High Interest Rates Destroys the Value of Assets. So owning a Depreciating Liability is NOT Exciting.
Renting is Exciting. And eating popcorn !
IMO both sides here got it wrong. I don't believe in a 80% drop but I don't buy the minor/ordinary/expected correction neither. Truth is probably in between, -30% would just wipe the 2 years of Covid rise, nothing to be impressed. That said, most (all?) indicators are in the red zone, so I'm wondering how things couldn't get "worse". I'm using quotes cause lower house prices isn't really a bad thing, leaves more to spend elsewhere. I'm yet to understand what justifies NZ houses to cost double/triple/quadruple what you'd pay for a house in other OECD countries.
Ok, a few things I would like to bring up with this article that it doesn't address from what I can see.
1. If your property but more so your investment property falls too far into negative equity, the bank can ask you to pay down the mortgage a significantly to meet its criteria. This usually happens more with investment properties if past downturns are anything to go off.
2. The current economic and geopolitical environment is very different to what we saw in the GFC. We could end up in a situation where inflation still remains high even when we enter recession. This may or may not put the hand break on any significant interest rate falls.
3. Pre GFC a lot more people could afford a property with one income. Now many even with two incomes struggle to pay these gigantic debt burdens given the higher interest rates we now face and higher cost of living. With more supply coming on to the market, migration currently low, tighter credit conditions and these factors above, there is increased risk here of a more significant downturn that we have seen in the past.
Banks will already have a list of Investors who own multiple properties.
They will go for them first because they can call in loans. The banks need to do this to secure their positions for themselves and the depositors.
The Investor will sell down as asked by the bank, but will soon realise it actually makes very little difference to the Investors exposer. But the bank will get their money back, that was the whole idea while packaged " We are protecting you".
When is the best time to sell ? - When you don't have to !
Emma Vitz referenced in this article was discussing how 'house prices double every 7-10 years' on Twitter. She seemed quite adamant that this is indeed true but couldn't really explain the dynamics. Someone suggested if there were a relationship between money supply growth. It all seemed a bit overwhelming for her. And she's an actuary by profession.
Not sure why people cannot get their heads around property doubling in price every 10 years because a whole lot of things double in that time. Sure it may not continue but its been that way the last 50 years so if you had to take a punt then you are going to put the money on it doubling again in 10 to 15 tops.
Not sure why people cannot get their heads around property doubling in price every 10 years because a whole lot of things double in that time. Sure it may not continue but its been that way the last 50 years so if you had to take a punt then you are going to put the money on it doubling again in 10 to 15 tops.
People who say these kind of things (like the double every 7-10 years prophecy) don't really understand compounding. Very similar to the grains of rice on the chessboard. I would think a professional actuary 'should' understand.
It's historically only persisted thanks to a downward trend in interest rates and period of high inflation (analysis tends to use nominal rather than real prices).
The downward trend in interest rates doesn't have much further to go unless we head negative. Any expectation of house prices coming close to doubling in real terms to me seems to be an expectation that interest rates will go negative in the next decade - otherwise I don't see how it can happen.
Place yours bets now, but be aware of the trends that have lead to these 'rules'.
The downward trend in interest rates doesn't have much further to go unless we head negative. Any expectation of house prices coming close to doubling in real terms to me seems to be an expectation that interest rates will go negative in the next decade - otherwise I don't see how it can happen.
We can wait with bated breath to see what miracles Kaumatua Orr is going to reveal.
So in other words, if you took on huge amounts of debt and bought an executive/family home that you can comfortable live in until you retire, then you'll be OK.
If you bought a modest starter home that you need more rooms to raise kids in, or plan on having a family and dropping down to one income, or you have to move for work or career reasons, or you have a health scare... you're not. You're toast. Not only is all your equity gone but you're still on the hook for what is left over when you do sell, even if it is to just go renting again.
Just who exactly are these 'you'll be fine, hunker down and smell the flowers' articles pitched at?
People are pulling out of deals due to fear of Interest Rates going to 12% -15%.
“We did the maths and, honestly, we could have afforded to do it [pay 10%],” Grimstrup said. “But what if they hike the rates to 12% or 15%? That is not something I want to go to bed at night worrying about.
https://www.stuff.co.nz/life-style/homed/housing-affordability/13046199…
I need to check if the seals are broken on those next 2 Scrolls in the back bedroom.
I also found it hard to feel sympathy for them - "the bank wouldn't look at my gross income, just my tax bill."
It's not gross income, it's your revenue, and your income is revenue minus expenses. The bank was entirely right.
For some reason, I thought embellishing incomes on finance applications counted as fraud - but maybe I've just misread something somewhere.
Those with no knowledge or experience?
Business Taught Masters (BTM) programmes (the author's job at the moment) provide you with an opportunity to diversify your knowledge by adding business skills.... BTM qualifications are accessible to students from any background and are delivered in a way that assumes you have no prior business knowledge or experience. You can dive straight into a master’s degree...
In relation to the GFC, the author writes:
This time around there will be fewer borrowers with mortgages that are a high fraction of the value of their house and fewer who can’t manage higher mortgage repayments.
This statement is so clearly and so obviously untrue that I am surprised it was allowed to be published in an interest.co article.
There are a ton of borrowers who jumped into the market at the peak to buy investment properties and upgraded homes, at 7, 8 and 9x DTI. Those kinds of DTIs just weren't a problem in 2008. The numbers are in the article that I have linked below.
The RBNZ has stopped releasing statistics on debt concentration, but considering the numbers in the article linked below, I wouldn't be at all surprised if debt concentration was at its highest, most dangerous, levels ever in NZ.
What is more, we have borrowers who took out mortgages within the last 24 months who are already facing interest rates higher than they were stress tested for. This problem is happening right now and is likely to escalate.
Unless interest rates drop fast, and soon, there will be an absolute flood of borrowers who cannot manage the higher mortgage repayments. Especially borrowers with multiple mortgages over multiple properties. And anyone who says otherwise (without some seriously good statistics or analysis to back their their assertion) has got their head stuck in the sand.
https://www.interest.co.nz/property/113230/new-reserve-bank-debt-income…
It may soon be in the banks interest to try and force some investors with larger portfolios into a selling position. Based on the overall equity position the bank can work out if they get all their money back. Just wait for one property to come up for refinance. Then play hardball. Other banks may not be willing to step in either. Puts a lot of property onto the market at lower quartile price point. FHB will be able to access FHB grants based on the raised limits of 2021. Brings some new borrowers into the market and some much needed liquidity. Otherwise everything is just stalled because only those that are forced to trade will do so.
Auckland is just a powder keg of risk.
Taken from the article linked above:
"... Auckland owner-occupiers with investment property collateral have... since September 2020 ... regularly seen in excess of 80% of its mortgage money advanced on DTIs of five and over."
Unless mortgage rates fall soon, there is a massive chunk of the Auckland property market that is getting to be quite high risk.
With mortgage rates where they are right now, anything with a DTI over five is looking almost sub-primey.
Yep - DTI * Interest rate equals the percentage of income attributed to interest alone. @6% and DTI of 5, 30% of income is going to interest payments only, not touching principle yet. All the while the value has dropped by ~15%;
(Equity - 15) / (100 - 15) = new equity.
That's equity minus 15, not minus 15%. So e.g. 40% equity minus 15 = 25. New equity = 25/85 = ~29%.
If you look at RBNZ lending data over 2021, some of the DTI stats are simply eye watering.
Negative equity is looming for some home owners – but you only need to worry if you need to sell
Agree that buyers who bought a house to live should not be worried as are in for long term but speculators and others should be be shit scared specially if have over streched under greed for fast money.
Many bought overpriced homes in poorly suburbs too, of which NZ seems to have a fair few... so who will buy the house if they have to sell? I'd think there will be a fair few stuck in half-gentrified neighbourhoods. Far from an ideal outcome from our rockstar housing market when you think of how many were sucked into the lie.
Doesn't even need to be negative equity to have an impact. If your LVR increases above 80% due to the value of the property falling, then most likely the bank will apply a Low Equity Premium.
For BNZ, that means if your new LVR is between 80 and 85 they add 0.35% to your interest rate, if it's 85 to 90 they add 0.75%, if its 90% to 95% they add 1% and above 95% they add 1.15%.
That could turn a 4.85% fixed rate into 6%.
Of course this only happens if the bank reviews your property value. Until they do, it's on their books at the price you paid for it.
But it swings both ways. If you had a 90% LVR in 2020 and now it would be < 80% given the new market value of your property, then talk to the bank to get the value updated and get any LEP removed.
"The bank doesn’t win if they force the sale of a home and get back less than they were owed. "
I wish this narrative was accurate or that anyone writing has the sense and integrity to be honest.
NZ does not have non recourse mortgages, so banks have you by the short and curlies and will take everything you own and land you with a unsecured loan to cover any shortfall.
Non recourse mortgages mean that you know what you stand to lose, mean you can just send the keys back and get on with your life, and may mean that the borrower won't have to be interrogated about their spending habits to "protect them", because the banks will be basing their loans on the value of the property, not how much they can squeeze out of the borrower.
When open banking comes along they will probably be allowed to clean out all your accounts at other banks too. "Let's make it easier for the customer" yeah right.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.