Wednesday, December 21, 2011

Negative equity blues - Trapped on the bottom rung

Chris Zappone published a piece today on the increasing number of Australians who are suffering from negative equity, that is owning a property worth less than the mortgage over it:
New reality: owing more than you own

There is no doubt housing has become less affordable in recent years.

Falling house prices may leave more households owing more than the value of their homes.

Rising property values have been an article of faith in the housing market for a generation of Australians who borrowed big as real estate prices marched ever upward.

Now, though, some buyers are finding that their homes are worth less than the size of mortgages taken out to acquire the proverbial roof over their heads.

While the percentage of home owners with so-called negative equity remains tiny - about one in fifty of the 3 million households with mortgages - the number may well swell in 2012 if home prices extend their declines as some analysts expect.

The emergence of a sector of the housing market ‘‘under water’’ on their mortgages may hurt an already fragile real estate market. Any forced sales would obviously dent individual household wealth but further drops in home prices would deter investors from buying residential properties.

Ben Phillips, principal research fellow at the National Centre for Social and Economic Modelling, helped prepare the analysis which pointed to 60,000 households nationwide with negative equity.

"The prospect of negative returns will certainly detract from sentiment through 2012," said NATSEM’s Mr Phillips. The Age
Now 1 in 50 homes in negative equity may not sound like a lot, but it's just another compounding problem in an already weakened market.

Here is a story about negative equity I read in a forum post the other day:
User A: Some friends of mine, after getting married, purchased a 2bdr unit with a small courtyard out past Hornsby, Sydney in mid 2009 for around 475k. They had a 5% deposit and i advised them to hold off a bit and save some more and look around, but they were adamant and wanted to get into property as it only goes up....

2 years down the track and they're looking for a larger place to start a family. They spent just over 20k doing it up (place really needed it). The value of their place has dropped to around $430k. There's no way they can break even and move so they're staying put. Travel is at least an hour each way into the city and they don't mind too much. least they have the train (how much is a weekly return to Hornsby ???)

They've sold one car as they cant afford the luxury of a second. They've got a large mortgage over their heads backed by a property they cant get rid of. Welcome to the world of the 1st home buyer nowadays - not an enviable position.
This was followed by another user who didn't seem to recognise the gravity of the situation, instead focusing on the potential that the want-to-be-upgrader could be better off as prices fall:
User B: Surely if the value of their property has dropped, then the value of the larger property that they want to move to has dropped, so the larger property is actually more affordable in $ terms than it would be had the market risen by the same amount.

ie you are saying value of their house has fallen by 13%, $495k to $430k. Let's assume that the $600k (2009) larger house is now for sale for $522k. So if they switch tomorrow they need to pay an extra $92k.

If the market went up 13% then their $495k would sell for $559k, but the larger $600k house would now be for sale for $678k, so they would have to find an extra $119k.
This was followed up by my post:
Bullion Baron: It may very well be the case that the larger property has also dropped but the issue of negative equity is still something difficult to overcome.

For example their 95% loan on $475k is approximately $450k. Let's assume they've paid down principal of $5k over 2 years so have $445k outstanding. If they sell their unit at $430k they will need to take out a personal loan to finance the $15k shortfall, plus any selling expenses (agent fees, etc), so potentially they will need to be able to finance and then service a $25k unsecured personal loan as well as working out how to find a deposit and finance for the new larger house.

While technically you have a point regarding an across the board fall (assuming that the larger house has fallen by the same amount as the unit), in reality it is not as easy as you might suggest to work around it.
Now I'm not ignorant to the possibility of falling prices being a benefit to some owners who wish to upgrade, I wrote this in a post earlier this year:
Chances are that many families that have to sell and realise the loss will be moving into another purchased home at the same time, so if their own property has fallen 20% and so has the one they are buying, then there is little loss to them. Bullion Baron
However upgrading from a position of negative equity could be very difficult (as I've already pointed out). Price falls are only going to benefit upgraders if they are in a position financially to take advantage.

The sad reality is that a large number of those now sitting in negative equity would be the First Home Buyers who have been sucked in by government handouts over the last couple of years. It's these buyers who are most likely wanting to upgrade having purchased their home with the intention of using it as a stepping stone. It's also these buyers who are now trapped in their homes with prices in many areas having dropped below their 2008-2010 levels. 

With first home buyers unable to move off the bottom rung of the "property ladder" this will have a flow on effect with those on the second rung unable to sell to the first they are in turn unable to buy the third and so on. With the property ladder broken and the property clock running slow I have to wonder just how many property memes are left to bust.


 Buy bullion online - quickly, safely and at low prices


  1. It is. I have friends and family in similar positions. Wanting to sell and unable to without taking on an unsecured personal loan to cover the shortfall. IMO its going to get worse before it gets better.

  2. Hey BB,

    Back in 2006 US Mortgages underwater (as the market rolled off the top) was under 3%, we are around this position now.

    Then it went pear shaped and its not linear, its exponential, as prices get to 95% of peak, then 90%, 85%, 80%, 75%, 70% you start taking out larger tranches of mortgagees.

    See the top graph here:

    Then read these stats (from 3% to a possible 48% in 5 years!):


    PS Merry Christmas

  3. These things have a tendency to snowball. What I would be interested to know is if Australian banks have done what US banks did, which is bundle large numbers of loans together and sell them to investors rather than holding the loans on thier own books. This practice creates a moral hazard to lend to people regardless of their ability to pay, since the loan orginator does not plan on holding the loan to maturity.

  4. SS,

    Yes they are called RMBS (mortgage backed securities) and our govt has bought lots.


  5. It will be interesting to see whether Australia follows the New Zealand (where i'm from) pattern.

    In New Zealand pty prices dropped in 2008 the same as just about everyhwere, rebounded a bit in 2009 and have basically flatlined since. Most places are still below the late 2007 high (the big exception here is perhaps parts of Auckland).

    Although NZ didn't get that extra year or two of increase (aka froth) after the onset of the GFC like Australia our affordability multiples are still crazy high by world standards and the NZ economy is far more vulnerable than Aust. Also, Auckland and Tauranga aren't exactly global cities (like syndey and melbourne arguably are).

    What happened in NZ when prices dropped?

    (i) Central bank slashed interest rates and has kept them low. Banks passed on this rate decrease so people can afford to service more debt which supports house prices (but meaning that rates can't go up or its kaput for many);

    (ii) banks initially tightened LVRs but are now back to lending 90%-95%;

    (iii) rather than sell up banks allowed a lot of borrowers to switch from principal and interest to interest only meaning less forced sales;

    (iv) in farm and wine sectors banks have almost stopped enforcing their securities and essentially allowed things to drag on and on in default limbo land - less forced sales again is supportive of property prices.

    (v) Govt knows where its bread is buttered and what th electorate wants. It tweaked the depreciation regime for property investors (reducing some outright rorts) but still no genral capital gains tax on pty in NZ. Tax treatment is still very favourable to pty relative to other investments and no hint that's going to change soon.

    Unless you've actually personally purchased a pty that's gone down (eg inner city apt or life-style block) for most people the property is the best investment can't go wrong maaaate attitude is still 100% unshakeable - especially for suburban Auckland (which makes up a hugh chunk of NZ pty by numbers and even more by value)

  6. @Jesse, I agree things will likely get worse before they get better. Those households wanting to upgrade but are trapped due to negative equity are further impacting volumes in a market that has already slowed to a crawl and it's only going to get worse. As bad as the US? I suspect not, but anything is possible depending on how the global macro situation plays out.

    @MarkyMark, It will be interesting to see whether most people will remain so positive if we see another 5-10 years of growth below inflation. Even if we don't see prices crash a long drawn out melt could also impact heavily on sentiment.

  7. UserB was entirely correct. The situation the couple now find themselves in, is better than if prices had risen.
    If they had expected to upgrade within 2 years then they should also have expected to increase their mortgage or save the upgrade difference within the two years. If prices have fallen they now have to increase their mortgage by LESS than they would have done if things had turned out as they expected ie if prices had risen.
    The "trapped by negative equity" is a furphy. All they have to do is synchronise the sale and purchase, as many many people do whether they have negative equity or not, and they can upgrade. The new mortgage will be less than if prices had risen. They are thus better off. UserB is perfectly correct. If there are timing difficulties with the completions of the sale and purchase their bank will be prepared to assist. If they expected to have the capacity to service the mortgage for an upgrade after prices rose they certainly have the capacity to service the mortgage for an upgrade after prices have fallen. They now need a smaller mortgage for the upgrade than they expected. It is not rare for sales and purchases to be synchronised - it is common practice.

  8. Anonymous, you will notice that I agreed with UserB in theory (that they would end up with a smaller mortgage), but in practical reality it is a lot more difficult than you are suggesting.

    As I showed in my calculations even just to sell the home they will end up with roughly $25k which they would have to cover with an unsecured loan, that's without taking into account stamp duty and 5% deposit in the second home. Using User B's example of $522k purchase they are looking at $19k stamp duty and $26k deposit (95% lend) on top of the $25k. So essentially they would need to find a personal loan of $70k to purchase the second home or find a lender who is prepared to finance them around 108% of the second homes purchase price.... good luck in the current lending environment.

    They are trapped by the negative equity, the synchronisation of the sale makes no difference to the practical reality of the above situation.