New LVR (Loan-to-Value Ratio) Rules
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Articles by Matthew Gilligan
As of 1st October 2013, the Reserve Bank has imposed limits on high loan-to-value mortgage lending.
What are the new rules?
Under these new rules, only 10% of a bank's new residential mortgage lending can be at LVRs over 80%. Up until now, high LVR lending has been at around 30%.
Why have they been implemented?
The Reserve Bank has implemented these measures because of concerns that the housing market is threatening New Zealand's financial stability.
Half of bank lending in NZ is for housing, and for most people their home is by far their biggest asset. House prices are currently high - Reserve Bank Governor Graeme Wheeler saying they are overinflated, especially in Auckland and Christchurch. This is for two reasons - a shortage in housing supply and easy credit.
A large correction in the housing market could put the stability of the banking system and economy at risk. We saw this happen in the US during the GFC, where house prices fell and 25% of borrowers ended up with negative equity, causing massive losses to both homeowners and lenders.
The idea behind restricting high LVR lending is to slow the rate of increase in house prices by reducing mortgage demand and competition. In turn, this should reduce the chances of a massive downward correction.
It is hoped that by adopting this strategy, the Reserve Bank will have more flexibility around when and how far it has to increase interest rates, which is the other obvious option for trying to control house price inflation.
The LVR restrictions would be removed once the Reserve Bank considers balance has been achieved in the housing market, or if they prove ineffective.
Will the restrictions work?
There is some debate as to whether the new restrictions will have the desired effect.
Firstly, Auckland and Christchurch are suffering from a serious housing shortage. When there is high demand and low supply, prices will naturally continue to rise.
Secondly, people tend to find their way around restrictions, e.g. by borrowing from non-bank lenders, which are not covered by the new rules. It is expected that more Australian second tier lenders will enter the market as a result.
Thirdly, more people may take out lower LVR loans. In other words, the new rule may change who will buy a property, but won't affect what they are prepared to pay for it.
According to Westpac economist, Michael Gordon:
“So we suspect that, over time, house prices would be bid up to much the same levels as they would in the absence of LVR restrictions – perhaps at a slower pace, with fewer competing bidders, but ultimately reaching a similar end-point.”
The reaction
There has been much debate, some of it heated, about these new changes.
Positive reactions:
• Could prevent buyers from having more debt than they can afford to service (and thus defaulting on their loans) when interest rates rise.
• Protects banks from having a high level of low LVR loans, which was one of the reasons for the collapse of the US banking system during the GFC.
• Reduces the number of borrowers that may end up with negative equity should house prices fall.
• With fewer people able to buy property, capital may be invested in other areas, which is arguably better for the economy.
• Prevents the Reserve Bank from having to sharply increase the OCR (which would force the dollar up and put pressure on NZ's export and import industries).
• Housing New Zealand's Welcome Home loans are exempt, allowing qualified first home buyers to borrow more than 80%.
Negative reactions:
• Unfair for first home buyers, many of whom don't have a chance of saving 20%, so they won't be able afford to buy at all.
• If homebuyers source funds from non-bank lenders, it could put them at greater risk because some such lenders can be less reliable and charge higher interest rates.
• The restrictions will limit business investment also, as most small business owners raise capital through borrowing against their homes.
• Pre-approvals above 80% will have many restrictions on them, and will be no guarantee that borrowers will be approved finance. This will make buying at auction a much more risky proposition.
• May reduce the number of new homes built, as 10% to 15% are purchased by low equity borrowers. This will not only slow housing supply, but will also have a negative effect on building companies.
What does this mean for you?
It's our opinion that being over committed financially with property is not a good idea. With a high LVR, it doesn't take much of a market correction for your equity to be eroded and to put you outside bank lending covenants. As a general rule we base our decisions on 80% LVR anyway, so the new rules make little difference to our investing modus operandi.
In any event, we suggest you consult with a good mortgage broker to source finance for you. If borrowing more than 80% makes sound financial sense for your situation, they will be able to advise the best means for doing this. Also if you need any tax or structure advice, please contact us.
Why have they been implemented?
The Reserve Bank has implemented these measures because of concerns that the housing market is threatening New Zealand's financial stability.
Half of bank lending in NZ is for housing, and for most people their home is by far their biggest asset. House prices are currently high - Reserve Bank Governor Graeme Wheeler saying they are overinflated, especially in Auckland and Christchurch. This is for two reasons - a shortage in housing supply and easy credit.
A large correction in the housing market could put the stability of the banking system and economy at risk. We saw this happen in the US during the GFC, where house prices fell and 25% of borrowers ended up with negative equity, causing massive losses to both homeowners and lenders.
The idea behind restricting high LVR lending is to slow the rate of increase in house prices by reducing mortgage demand and competition. In turn, this should reduce the chances of a massive downward correction.
It is hoped that by adopting this strategy, the Reserve Bank will have more flexibility around when and how far it has to increase interest rates, which is the other obvious option for trying to control house price inflation.
The LVR restrictions would be removed once the Reserve Bank considers balance has been achieved in the housing market, or if they prove ineffective.
Will the restrictions work?
There is some debate as to whether the new restrictions will have the desired effect.
Firstly, Auckland and Christchurch are suffering from a serious housing shortage. When there is high demand and low supply, prices will naturally continue to rise.
Secondly, people tend to find their way around restrictions, e.g. by borrowing from non-bank lenders, which are not covered by the new rules. It is expected that more Australian second tier lenders will enter the market as a result.
Thirdly, more people may take out lower LVR loans. In other words, the new rule may change who will buy a property, but won't affect what they are prepared to pay for it.
According to Westpac economist, Michael Gordon:
“So we suspect that, over time, house prices would be bid up to much the same levels as they would in the absence of LVR restrictions – perhaps at a slower pace, with fewer competing bidders, but ultimately reaching a similar end-point.”
The reaction
There has been much debate, some of it heated, about these new changes.
Positive reactions:
• Could prevent buyers from having more debt than they can afford to service (and thus defaulting on their loans) when interest rates rise.
• Protects banks from having a high level of low LVR loans, which was one of the reasons for the collapse of the US banking system during the GFC.
• Reduces the number of borrowers that may end up with negative equity should house prices fall.
• With fewer people able to buy property, capital may be invested in other areas, which is arguably better for the economy.
• Prevents the Reserve Bank from having to sharply increase the OCR (which would force the dollar up and put pressure on NZ's export and import industries).
• Housing New Zealand's Welcome Home loans are exempt, allowing qualified first home buyers to borrow more than 80%.
Negative reactions:
• Unfair for first home buyers, many of whom don't have a chance of saving 20%, so they won't be able afford to buy at all.
• If homebuyers source funds from non-bank lenders, it could put them at greater risk because some such lenders can be less reliable and charge higher interest rates.
• The restrictions will limit business investment also, as most small business owners raise capital through borrowing against their homes.
• Pre-approvals above 80% will have many restrictions on them, and will be no guarantee that borrowers will be approved finance. This will make buying at auction a much more risky proposition.
• May reduce the number of new homes built, as 10% to 15% are purchased by low equity borrowers. This will not only slow housing supply, but will also have a negative effect on building companies.
What does this mean for you?
It's our opinion that being over committed financially with property is not a good idea. With a high LVR, it doesn't take much of a market correction for your equity to be eroded and to put you outside bank lending covenants. As a general rule we base our decisions on 80% LVR anyway, so the new rules make little difference to our investing modus operandi.
In any event, we suggest you consult with a good mortgage broker to source finance for you. If borrowing more than 80% makes sound financial sense for your situation, they will be able to advise the best means for doing this. Also if you need any tax or structure advice, please contact us.
For more information on loan structures whether to fix or float check out the Professional Trustee team's blog.
Matthew Gilligan
Director
© Gilligan Rowe & Associates LP
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Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.
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