There was a time in New Zealand when housing was affordable and buying a house to raise your family was not as inaccessible as it is today.
Over the last decade, housing has taken a critical role in our economy. It is now a significant source of value and risk to both the household sector and the banking system of our country.
New Zealand saw mighty house price rises of about 114% (82.5% inflation-adjusted) from 2001 to 2007. During those carefree days, some banks were offering 100 per cent-plus mortgages, as they saw the increasing value in property accompanied by a sharp increase in the low-deposit loans.
But then the Global Financial Crisis (GFC) happened in 2008, and the banks realised they were overtly exposed to risk as capital gains on housing disappeared. The Reserve Bank of New Zealand (RBNZ) recognised that borrowers with less than 20 per cent deposit (and investors with less than 30 per cent) are often stretching their financial resources and they are more vulnerable to an economic or financial shock, such as a recession or an increase in interest rates.
To eliminate those sorts of risks, the RBNZ brought in the loan-to-value ratio (LVR) restrictions in 2013 to create a buffer and reduce the risk in the event of a sharp housing downturn, which would affect highly-indebted households. This restricted the amount of low deposit (high-LVR) lending that the banks can make.
The LVR policy helped to strengthen bank balance sheets, slowed down the investor market with its lending limits and the household debt was controlled by having homeowners with at least 20% equity in their house. Overall, the objective was achieved.
The restrictions have been revised over time, but to the surprise of many on 29 April 2020, the Reserve Bank removed the high LVR restrictions for 12 months in response to the economic impact of the COVID-19.
That’s right; Reserve Bank wants to free up lending when the housing market is likely to be heading for a significant correction. So, it’s up to the banks now to decide what proportion of their lending will be high LVRs (aka low deposit) loans.
LVR restrictions are one of the four macro-prudential tools used to help reduce risks with rising household debt. In 2019, Fitch Ratings reported that New Zealand has one of the world’s highest household debt levels, at 93% of GDP.
So why would the RBNZ take LVR restrictions to the woodshed which could potentially push the household debt to newer heights when uncertainty abounds?
During an economic downturn like the one we are currently facing with potential double-digit unemployment levels, many homeowners will experience mortgage stress, struggling in servicing interest and/or principal repayments. Paying back the debt is going to be tough for households if their earnings fall. Thousands of kiwi households were already granted six months mortgage deferrals by the banks which will eventually increase the size of their loan repayments.
Housing loans represent roughly half of the bank lending in New Zealand, and a home is usually the single largest asset that a family owns. Around 40 per cent of residential mortgages in New Zealand are issued at more than five times the borrower’s gross income and with LVR restrictions dropped for 12 months, it is possible to buy properties with lower equity. But that is a risk for both borrowers and banks with a volatile housing market.
We’ve seen this movie before. In 2008, trillions of dollars in mortgage debt amassed during a huge run-up in residential real estate and that had to be unwound, contributing to a worldwide recession that was deep and destructive.
Reasons for strong house price rises in New Zealand have been the healthy expansion of our economy, low-interest rates and high net immigration.
But right now, the housing market looks very vulnerable with plummeting tourism revenue which accounts for 6% of our GDP and immigration at a halt for the next year at least. And low-interest rates with relaxed lending doesn’t sound like a sustainable plan.
When we exit ‘the dark side of the moon’ and get to the other side, there are going to be ramifications the RBNZ will have to tackle.
For new homeowners they will need to take a very long view to home ownership and understand that potentially they may be underwater for a period of time with more debt owing on their home than its market value. Property is a lag indicator, meaning that negative results seen on the front pages of the newspapers or the evening news don’t immediately materialise into negative results on property values for some months.
The Irish tale: Ireland, like the United States, had a property bubble built on debt, fuelled by reckless lending and tax incentives. When the bubble burst in 2008, starting a deep recession, real estate prices plunged, people defaulted on loans, construction came to a halt and Irish banks, deeply indebted to foreign banks, came close to liquidation.
Homeownership fell from about 80 per cent of households to fewer than 70 per cent – the lowest than it had been in Ireland in four decades.
House prices in Ireland have rebounded since the recession, but homeownership has not, partly because people paying high rents often cannot save for down payments. A lot of young people in Ireland now realise they will never be able own a house, and that is a terrible outlook when you live in a country where a house is usually your main asset for drawdown in your retirement years.
Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, A Hawke’s Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
