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As house prices fall, negative-equity risk looms larger for new buyers
Negative equity – when a property is worth less than the remaining value of the mortgage on it – is most likely to hit recent homebuyers in the rising interest rate environment as property prices fall, according to a new analysis from AMP.
Notably, recent homeowners make up a majority of the housing loans in Australia, while national dwelling prices have fallen 9 per cent since their peak in April 2022, taking prices back to July 2021 levels.
“In our view, the risk of mortgage stress lies with recent borrowers (those who have taken out loans between 2020 and mid-2022), which is around 62 per cent of outstanding housing loans,” AMP senior economist Diana Mousina (pictured) said in a research note.
“These households have not had time to build prepayment buffers, have faced large declines in home prices, have had a very fast repricing of mortgage rates, are more likely to have taken out larger loans and were probably not stress-tested for the current increase in interest rates,” she added. “We think that the downside risks to the household sector are greater than the RBA (and most commentators) are estimating.”
On the RBA’s own figures, 0.5 per cent of all home loans outstanding are currently in negative equity; this would rise to 1 per cent if home prices were to fall another 10 per cent, which is close to AMP’s forecast for the peak-to-trough fall in house prices.
“A housing price crash (which would see prices fall another 20 per cent) would see negative-equity loans rise to 4 per cent of total loans, which is still low, but this underestimates the risk for new loans,” Mousina said. “Another 20 per cent fall in prices would see 10 per cent of new loans go into negative equity.”
Big banks could get hit by defaults
This risk of rising negative-equity loans creates vulnerabilities for banks and householders, according to the RBA. “A very large decline in housing prices would result in a larger share of borrowers falling into negative equity, increasing potential losses for lenders if borrowers default – this risk is most pronounced if unemployment rises sharply,” the central bank said in its recent Financial Stability Review (FSR).
However, Morningstar banking analyst Nathan Zaia said, the low level of unemployment will help to offset the risk of home loan defaults. Household savings and prepayments provide additional support to homeowners, which will also help to protect banks’ profits.
“I don’t think loans in negative equity will be a material driver of bad debts for the banks,” Zaia said. “Negative equity on a loan is one thing, but it doesn’t give any insight into customer serviceability or other assets the borrower might hold.”
Zaia did note, however, that Commonwealth Bank of Australia and National Australia Bank have posted the strongest home loan growth in recent years among the majors, so they could be the most vulnerable to loan defaults, even if the risk is low.
“The starting point is those banks might have a less mature loan book, [with] more loans where customers did not benefit from house price appreciation,” he said.
“But I don’t think we can draw any definitive conclusion on which bank might be at greatest risk. It depends on what percentage of those new loans were 80 per cent-plus loan-to-value ratio (LVR), what percentage of higher LVR loans were also high debt-to-income borrowers, plus what percentage also have lenders mortgage insurance.”
Households well supported, for now
According to Mousina, the high level of accumulated savings for some households will protect homeowners from low defaults, as will the low unemployment rate. The value of Australian household accumulated savings is around $250 billion, or about $26,000 per household, thanks in part to government transfers and interest rate cuts during the pandemic.
“Savings will be run down over 2023 as interest rates increase and higher inflation lifts the cost of living, but it could take most of 2023 to completely run down total savings,” Mousina said. “However, most of these savings are concentrated in high income earners.”
Strong house price growth over recent years also means most households have substantial equity buffers in their homes. “Just 5 per cent of loans in the bank’s securitisation dataset were estimated to have an LVR greater than 75 per cent as at August,” the RBA said in its FSR. “Moreover, very few loans were in negative equity at that time, and… very large further declines in housing prices would be required to materially increase the share of loans in negative equity.”
As interest rates rise, fewer Australians are taking out home loans. The most recent data from the Australian Bureau of Statistics showed the overall value of new home loans dropped 5.3 per cent to $22.1 billion in January 2023. Breaking that down, the value of total owner-occupier new home loans fell 4.9 per cent to $14.7 billion, while new investor loans fell 6 per cent to $7.4 billion.
Loans to first-home buyers also fell to a five-year low in January. Mish Tan, the ABS’ head of finance and wealth statistics, said the number of new owner-occupier first-home-buyer loan commitments fell 8.1 per cent in January 2023.
“Owner-occupier first-home-buyer lending continued to decline from the high reached in January 2021,” she said. “The decline coincided with the winding down of COVID-19 pandemic stimulus measures.”
