Negative Equity in Housing and Homeowners Protection

Not necessarily a problem.

As they are young, it is highly likely that they will experience many property cycles (upturns, downturns and treading water) through their lives.

If they have a short term outlook and decide to sell their properties to get out before they lose more equity, then there may be a problem.

Otherwise, the younger one is the more likely one is able to ride out this part of the cycle and have long term capital growth. This is what happened the last time property prices fell
those who were patient and rode out the cycle then had capital growth in the long term. While past housing price cycle may not represent future situations, I believe that most economists and those in the financial sector would agree that in the long term there will be a price upside, providing there is no major economic catastrophes (e.g. Australia becoming a banana republic with hyper inflation or a civil war for example), no differently to that which has occurred in the past.

If one has negative equity and about to retire, well, it is a gamble that didnt pay off and they may chose to use their super to pay out their loan or sell up and downsize to something more affordable.

I must agree with @frsampson about the likely adoption of negative equity insurance by the insurance industry
it would be extremely high risk to them and would encourage those with negative equity to take cover (with manditory waiting period) prior to selling to reduce their own exposure to loss. The public sector (government) should also not take on such risks as it will encourage risk taking at the expense of providing public services as a whole.

Education/information to those with negative equity when making financial decisions may be the key rather than someone else/another institution taking on the full risk on behalf of thise who find themselves in such situations.

The oniy other solution would be to adopt a doctorine where the government provides public housing to all of its citizens to remove any potential housing/financial risks to the same citizens. This has been tried in other countries but eventually capitalism seems to prevail.

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Only if they cannot keep paying as rates rise, if they keep up the payments it isn’t an issue. Nobody comes along and says “you are in negative equity we shall hurt you” if you keep paying. There are many reasons some cannot keep up repayments.

If you say people should consider if, when they are borrowing at 5%, they can repay at 10% then I agree. And so should the lender.

So far you haven’t shown me how your scheme isn’t a discount on market rates and you haven’t said who pays for it.

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HI Php good to hear from you again. The proposed negative equity insurance only relates to those properties financed by lenders with lenders mortgage insurance (LMI) and are therefore have a higher risk. The lenders are covered up to the debt by the LMI with is paid for by the borrowers, usually up front and often added to the debt. The issue is that if a default should occur than there may be a gap between the proceeds of the mortgagee’s auction and loan which the borrower is then liable for. It relates to the loan being in default and there is no benefit to the borrower other clearance of the debt. The premium of the LMI protects the lender. The borrower’s mortgage insurance would relate to the gap up to the amount of the debt in the case of default. Inappropriate use of this facility can readily be covered by the terms and conditions of the product, the same as LMI. It comes down to fairer risk management that provides a better outcome to the lender and the borrower.

The result of this is that lender should view negative equity as a less risk to them in the case of fixed rate housing loans where there is an exposure to break costs in case of default on a fixed rate loan where the counter contract would be broken because of the default.

This is an issue that should be examined thoroughly by ACA because it is going to become an issue in a very short term if the property market continues its current trend. The issue that is important to Australia is this: " In Australia one of the most important considerations is the fact you are likely to move your place of residence. The Australian Bureau of Statistics research says that 45% of households of parents with dependent children move every five years. You can read about it here . This means that portability of a loan is a very important issue in a mortgage product."

There is no doubt that education is a critical factor as the UK experience has shown. In my view, it should not be left to market forces and exposing consumers to being collateral damage. They are better forewarned so that they can seek professional advice.

I am a believer in better risk management rather than reliance on public housing. However, I am aware of the importance of NGO in this area.

Thanks for the discussion.

Regards

John Cosstick

Hi Syncretic. Thank you for your comment. The same people who pay for LMS to protect the lenders would be paying for the Borrowers Mortgage Insurance - the borrower.

You can readily check the difference between fixed rate loans and standard variable home loan interest rates by visiting https://www.canstar.com.au/ or similar comparator websites. These are market rates.

Lenders have a vested interested in their clients avoiding mortgage stress and should pay for their own risk management systems. However, I suspect that it will be like Lenders Mortgage Insurance, the consumers will pay for it.

Thanks for contributing to this discussion.

Regards

John Cosstick

All of Townsville is in negative equity currently. So that’s around 110,000 homes.

Hi Michelle. Words cannot express my sorrow at what happened in Townsville and the surrounding areas. However, for most this will be an insurance matter which I hope that the insurance companies will treat claimants fairly. The United Kingdom still has about 500,000 homeowners still in negative equity as a result of the impact of the GFC and the widespread market correction in the value of real estate. Negative equity after a market correction in housing can last a long time.

The scenario we have been discussing here relates to a mortgagee’s auction shortfall following a forced sale caused by a default. The issue of contention is whether lenders mortgage insurance, paid for by the borrower, should have a gap insurance, also paid for by the borrower. This would, of course, be like the lenders mortgage insurance and would have appropriate terms and conditions of the product so that it could not be misused for other than the purpose it was intended which is to protect the consumer and to prevent bankruptcy over the shortfall.

The purpose of this post is to start the conversation about this topic which I consider fair and reasonable because, after all, the consumers does pay for the Lenders Mortgage Insurance to protect the bank.

Michelle, I hope you can see where I am coming from. Reform starts by talking about issues and trying to fix them. It has always been that way.

I hope that you were not too badly impacted by the floods which, to us in the South, were incredible in their intensity and coverage.

Kind regards.

John Cosstick

Couldn’t agree more as in Australia’s property speculation mindset, buying one’s home is as much as an investment as it is a roof over one’s head. If a person/s paid too much for their home/s or they over capitalised it should the nanny state ride to their rescue? Conversely if the nanny state did come to the rescue will those homeowners if they eventually develop positive equity will they share the benefit with the nanny state?

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Hi tndkemp. Thanks for joining the conversation. The scenario envisaged only applies to those borrowers who have paid the lender’s mortgage insurance to protect the lender, but wished to insure themselves against negative equity in case of default and foreclosure, sale and resultant shortfall. This would of course be subject to the terms and conditions to prevent misuse of the product as is LMI. Most of the people impacted would, I imagine, be young first home buyers with high LVR and both working. There is interesting times ahead in 2019 for Australia and the world.

Thanks for joining the conversation.

Regards

John Cosstick
P.S.
I am very pleased to see the Mike Taylor, The Editor of Money Management has an article in the latest issue saying that “Choice wants a voice on RC rectification taskforce”. A position I would have thought should have been obvious!

Hi John, it is always useful to consider what might be, even if it seems unlikely.

Let me know if I don’t have this quite right.

The concern is Australian banks will not renegotiate housing loans for existing borrows who are in ‘negative equity’?

Or more precisely Australian banks will insist that when a fixed term housing loan ends or the borrower looks to move from a variable to a fixed rate loan, the banks will only offer a variable rate loan without any discount! That seems very normal for any loan scenario.

If we look to the UK example. Australian banks and UK banks are not the same. The environments are not the same. In the past Australian home owners have faced the situation of negative equity, escalating interest rates and declining resale values. What happened then, providing you could keep up with the repayments?
My recollection is that it has been the ability to meet repayments in times of high unemployment or high interest rates that create the stress.

Is there any evidence Australian banks are refusing customers renegotiating and moving from a variable to fixed rate loan?

With any bank if the term of a conditional loan expires, the customer entered into the loan supposedly knowing there are risks, and uncertainties with the conditions that might exist in the future. What has changed?

Negative equity may for many be just the consequence of a bad investment decision or poor financial planning advice?

Re losses on loan default.
In your proposed solution re insurance. Obviously the two common types of mortgage insurance are limited in cover.

Mortgage Protection Insurance provides some protection for borrowers defaulting in repayments for a period of time (perhaps 3 months) or the full amount of the loan in the instance the borrower dies.

Lenders Mortgage Protection provides the Bank or lender with some protection against default in repayments. Again this is limited assuming that after a period of time the loan is in default, and the lender sets out to sell the property.

Neither provide cover for the gap/shortfall between what the Bank/lender re recovers in the resale of the property and what is outstanding on the loan plus costs?

I wonder what the insurance cover might cost? The bank/lenders Mortgage Insurance does not cover the shortfall otherwise Aussie banks would simply walk away and array the loss.

As a borrower I would not want to share the risk with others through any Mortgage insurance I pay. Would the costs be shared across all loans or only added to high risk customers loans?

It appears that what is being suggested is for us to place a bet with the insurer on the future value of our property investment, national economy and property cycles. They are betting our property will always be worth more than today’s fair value?

I’d rather pay the extra off the principal on the loan than place that bet. The odds are not that good right now! In particular when the winner might be called in the first furlong when you least expect it.

Would you exempt all investors from the proposal and limit it to owner occupiers who own only one property? Investors have other means to cover their mistakes!

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A counterpoint. Why should buyers be protected against the future value of their homes falling? It is an investment like shares that can go up or down and having a margin call, or buying a car at top dollar (with a commensurate loan) that was expected to become a valuable classic but did not.

Most loans require collateral. When a mortgage is taken out the loan to value requirement might be 100%, 90%, or 80% as typical amounts. At 5 years if the property has lost value refinancing revisits that requirement. Buy at $1 million and get an $800K loan, but at 5 years the mortgage balance will still be substantial and you might have a house with an $800K value, and that 80% LTV only qualifies for a $640K loan and even at 100% it might not make the amount required. It is neither magic nor the province of doing customers over.

In the US as was referenced people just walked from their ‘underwater’ loans and defaulted the properties, usually unsellable in their current market for sufficient value, to their mortgage companies, who in many cases got their own insurance payouts, and dumped the houses on the market leading to a further fall in values in the areas so affected. The mortgage holder got a default on their credit record for a few years.

Others felt obligated to maintain their credit. To wit I bought a house in the US (1987) for $100,000 in a depressed market where the vendor paid the mortgage holder $20,000 at settlement to cover their mortgage balance above my purchase price.

Perusing this topic I focus on the problem people have refinancing at the end of a mortgage period, and that is a problem for them, but why should real estate become a precedent to protect anybody from everything where they expected to profit in some way but did not?

The variable rate so popular here is comparatively rare in the US. People make conscious decisions to take risks of rates going up, versus paying a bit more that is a constant over the period. US mortgages are generally 20, 25, 30 or even more years at fixed rates.

While I have been out of the US housing market for a few years mortgage insurance was paid by an additional monthly premium as part of the mortgage, not loaded on the front as a lump sum. If one had or achieved an 80% or better LTV you did not need mortgage insurance and could cancel if you had it included. Some mortgages had prepayment penalties but those I was familiar with did not or they were modest amounts, unlike prepayment of a vehicle loan whereby the rule of 78 (?) is a normal rip when paid early.

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Hi Marc. Thanks for participating in this conversation. Overall, we are discussing better risk management for home loan borrowers which, in part, has been prompted by Mike Taylor’s article in Money Management calling for housing loans to be financial products. Mike is the Editor of Money Management. You can read his article here: https://www.moneymanagement.com.au/news/financial-planning/mortgages-are-financial-products-and-need-advice. It is a position that I agree with.

There are two risks: interest rate risks and negative equity risks. That is a very simplistic view. If you take Mike’s view, than the interest rate risk and repayments should be equated to the client’s ability to repay the loan and avoid mortgage stress. For variable interest rates this means equating the repayments to their budget. With the rolling 50 year average of the standard variable interest rate in Australia being about 8.3% p.a. this means that we will a systemic weakness if the experience in the UK holds true for
" Most lenders will not let people with negative equity switch to a new mortgage deal when their existing one ends.

Instead, they will normally be moved onto the lender’s standard variable rate."

The assumption is that lenders believe that borrower’s in negative equity would be a greater risk.

I believe that Mike is right and lenders (plus mortgage brokers) and financial planners need to manage the risks better for consumers. This would mean in all probability a switch point calculator approach related to their budget Silos should not be allowed to exist in advice e.g in a bank’s lending division and a financial planning division. .

I believe that this is something that should be clarified for consumers by the Australian Consumers Association in writing with the Australian Bankers Association under their Code of Practice.

As far as the negative equity risk for borrowers I think that if Mike’s approach is adopted then there would be a duty of care to act in the best interest of clients. However, this may yet be resolved by the courts over the next few years.

This is an important discussion in my opinion as the next few years will show. The IMF issued a warning in 2017 about the same time as Mike wrote his article: https://www.theaustralian.com.au/news/imf-warning-to-australia-over-rapidly-growing-debt/news-story/ea49135ed024f9efd3b64655f6c330b8.

Regards

John Cosstick

Hi BBG, Thanks for participating in this discussion.

I think I have answered most of these questions with a reply to Marc (see the reply). However, if I have not please draw my attention to the section you wish to discuss.

I think Mike Taylor’s (The Editor of Money Management) article and approach is correct.

Regards

John Cosstick

John,

We may just need to agree to disagree here.

There is no evidence that Australia’s banking sector mimics or follows that of the UK or any other major western democracy. Which nation did not go into recession with the GFC?

The comments that Australia will follow the UK has no basis and respectfully I will choose to reject the need for the actions suggested.

In respect of financial management, banking and mortgages we have strong recommendations from the recent RC. Implementing these should in my view be the priority. They address real proven issues for all bank customers.

I don’t accept Mike Taylor’s view point. Neither did a number of the posts following the linked article.

The second article incidentally is behind a paywall for the Australian. I don’t consider the Australian as a reliable source of balanced reporting. Whether the article is reliable and relevant I can’t comment. I choose not to subscribe and waste my money.

You have made your point and given all of us something to think about, if indeed your crystal ball is any better calibrated than the majority of Australia’s many other recognised expert commentators.

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I’ll just go with @mark_m’s reply and add a few comments.

it should be the home loan borrows duty to manage their risks, not society’s, and not the lenders once the initial hurdle has been met. Lenders can only do so much due diligence and they have been caught out not doing it by the RC, but that does not mean it is their responsibility to ‘become the essence of the borrower’ and thus take the borrowers’ responsibility for poor judgement or naive or ill founded decisions they make.

They would as there is greater inclination to walk if things got too difficult.

We too can choose to disagree.

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Thanks BBG.

The pages of history have already spoken: https://www.globalpropertyguide.com/news-some-of-britains-wealthiest-areas-hit-by-house-price-drops-of-up-to-25-percent-3690 and shown that the IMF and Mike Taylor are right. The alternative strategy of having to lift families’ income who are in negative equity to pay down the debt has already started: https://www.freelance-work-guide.com/freelancing-repay-housing-negative-equity.html.

This is simply following the IMF’s work: https://www.imf.org/external/POS_Meetings/SeminarDetails.aspx?SeminarId=263.

This is going to be a tough lesson for Australia and a long hard struggle for many families.

Yes, we agree to disagree.

It has been an important conversation.

Thank you.

Regards

John Cosstick

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I find it difficult to understand how it will be struggle for families who property enters negative equity and their other financial circumstances haven’t changed.

In Australia, if for example they are on a fixed term loan and the term expires, if the mortgagee has trouble refinancing the loan through another financial institution, they still have the option to negotiate and refinance through their existing institution. I expect that this will be highly possible as it is in the interests of both the lender and the mortgagee to have a loan package which is affordable. I don’t think a lender will screw down hard with a negative equity mortgagee as it isn’t in the interests of the lender to have this mortgage in default or for the property to be taken over by the financial institution
where the bank would then be responsible for the loss of equity on its sale.

The survival of the institution is very much dependent on the mortgage staying afloat.

There are always property which go into negative equity for a number of reasons, it could be due to housing price correction (like that which Australia is currently experiencing and has experienced in the past) due to changes in local environment (e.g. a new freeway project over the back fence), local employment conditions (such and the ‘boom’ and ‘bust’ nature of the mining industry and the supporting regional centres) etc.

The challenge with a negative mortgage type insurance cover is who will know when purchasing a property if their property will have a reduction in value and enter negative equity territory. I expect that most at the time of purchase wouldn’t be buying anticipating that this will be the case as most would not make the property purchase if this is known (why would one buy say a $500K house today then next year it would be $350K). One is more likely to rent and wait until $350K market arrives.

So based on this, the only time one would likely take out negative equity type insurance is when a property has entered a period of negative equity
and in the event that the house would need to be sold (either by the mortgagee or the financial institution in the case of a default and repossession).

The risks to the insurer would be enormous as the insurer would not be able to spread the risk and costs across consumers who are both in positive and negative equity, as it will be those in negative equity only taking cover. Such would result in very high premiums which would add additional burden to the negative equity mortgagee and increase the likely risk of mortgage stress/not meeting repayments due to extended financial costs of servicing the loan.

The only way to overcome the bias of negative equity mortgagees taking out cover and to spread the risk across the whole of the mortgagee community, would be to legislate that every mortgage needs to take out such insurance. Doing such would be a very slippery slope politically and many like myself wuld not want to pay a premium to cover those who find themselves in a negative equity position.

Historically in Australia, negative equity positions usually are highly temporal and invariably overt time the property returns to a positive equity position. This chart shows the average house prices since 1880s:

There has been a number of times when there has been periods of capital value decline of properties, particular in modern economic times.

The issue I have with negative equity insurance type cover is that it transfers the risks associated with making a significant financial commitment like a principal place od residence, to another party. I believe in the long term this will increase speculation within the property market as one would know that it is possible to transfer ones risks and be covered by another party. Such is not a good economic principle and would encourage the wrong behaviour of many (either intentionally or unintentionally).

As outlined in another post, education on what negative equity means would be far better solution and allow an individual to take responsibility for the risks one accepts. If one for examples knows the risks of negative equity position and choses to sell ones house, then this is something they need to manage (defer selling, rent another place and rent their principle place of residence etc).

If one can’t afford the financial commitment of servicing a property in negative equity, it is also likely that they won’t be able to afford any insurance premiums and/or servicing the mortgage in the longer term. While this may be unfortunate, maybe it may be a hard lesson for the same individuals to take through the rest of their lives.

The final comment due to unfortunate circumstances one’s financial risks don’t pay, Australia has a generous social security system which one can rely on to provide a basic standard of living. Such is not possible in many countries such as the US.

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The tax code allows them to write it off as a loss. Therein lies one of the relevant issues. The financial institution plays an accounting game, not a property game.

Consider the scenarios or reasons why a rational person might pay on a $500,000 loan for a $400,000 property. If they were sure the price would bounce back it would make sense, and historically that has been the case. But in places where industries (mostly mining as well as small regional areas) that will not always be the case.

I am not supporting walking from debt, but if you own a depreciating asset would you want to pay more than the asset value plus interest along the way? Should one be protected as some believe, and would that have an impact on one’s propensity to try making the best financial decisions, or to just accept the safety net and do whatever?

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H PHP, This paper by the Bank of England explains why negative equity matters: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2009/the-economics-and-estimation-of-negative-equity.pdf. This OECD paper explains that globally wages are stagnating: http://www.oecd.org/newsroom/rising-employment-overshadowed-by-unprecedented-wage-stagnation.htm. We are not the only country with this issue of young families deeply in debt and in negative equity: https://www.theglobeandmail.com/real-estate/the-market/housing-crash-would-sink-young-canadian-homeowners-study-finds/article27169891/.

Which ever party wins the election this is an issue that is going to have to be addressed in the short to medium term.

I accept that we agree to disagree on market forces should be allowed to prevail and individuals should be responsible, but it does not alter the fact people in or approaching negative equity should be educated about their situation and what to do about it - seeking professional advice early is critical in my view. The first step in solving this issue is discussing it. Thanks for your help in doing this, it is greatly appreciated.

Regards

John Cosstck

You have more faith on our pollies than I. As we all notice they tend to do jack all until an election looms and then roll out the bribes, that could be core promises, non-core promises, and even the imaginary promise that needs to be carefully scripted and written as inviolable party policy.

Conclusion: it will be a long term partisan plaything that is important prior to elections but not nearly so important immediately after them, at least until the next election. In the meantime one side continues to tout their trickle down theory, and the other side gets so pincered by attacks of ‘class warfare’, ‘socialism’, ‘border security’, and so on that appeals to an impressively large segment of ‘us’ (about 38% + ‘enough others to get elected in our system’) they follow along, although not with similar zeal.

I look forward to having a real difference of government, not just a difference crafted by their PR teams.

As for the young families, et al, unfortunately most pollies see them as either an end to their means of being elected, or as acceptable collateral damage, depending on how safe a particular seat may be.

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Hi BBG, I wish I could say that I totally disagree, but I still believe that the majority (middle income Australia) will prevail and any political party that ignores them will ultimately fail.

It will be an interesting 6 weeks or so.

Regards

John Cosstick

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