How to hold back a flood of mortgage defaults when loan holiday is over

As property chat experts are acutely aware, Australia has the 2nd highest level of household debt. Most of this debt is concentrated in the Melbourne and Sydney housing bubbles.

COVID19 now means a lot of that debt is no longer serviceable. Australia is currently on life support, but like any patient, this can't last forever.

This academic says banks should take equity stakes in the housing bubble.

How to hold back a flood of mortgage defaults when loan holiday is over

Instead, why not convert the debt owed to the bank into a bank equity share in the house? The borrower sacrifices some part of future capital gains on eventual sale of the house but no longer needs to make mortgage principal repayments. Such an arrangement of banks having an equity stake in properties of their customers is not a new concept.

Should banks take an equity share in the Australian housing bubble, or will this just lead to the collapse of the banking system, when the bubble blows?

 

... and the bank ends up with a non-performing asset - no income to offset their borrowing expense.

 

Don't worry, everyone here on PC who abhor Govt intervention (probably the majority) will be on posting shortly to denounce such interventionist measures

 

I know we like to say that but how is this measured?

 

This reminds me of the many post of the P&I cliff that so many posted about.

 

Overblown. Most are using it as a break to spend the money on themselves. Listen to the last macrobusiness podcast. Only a small percentage is having trouble and it's mainly commercial in trouble....

 

No commercial = no jobs = rising unemployment = more defaults = less commercial =.......

Commercial in trouble doesn't come without a cost. Scentre today posted a $3.6b loss, Mosaic brand is closing up to 500 stores after being locked out of Scentre locations, there will be ramifications in the retail sector either way this plays out. In other news, Accenture sacking at least 25,000 staff globally probably 250-500 in Australia...this is the start so mainly commercial in trouble tends to eventually gravitate to affecting people.

 

It will be a case of negative equity, loan value will
be greater than the value of the property

 

Chalk and cheese

This actually happened, banks have implemented this policy and it means an increase of around 40% on loan repayments. Impact has been buffered to some degree by interest rates dropping

However, those with large portfolios will feel pain, some on PC have had to offload properties.

 

Lenders are fully aware of the assistance to borrowers running out, they have been from the very beginning. There was an initial flood of people applying for loan deferrals, once that was over the lenders focused their attention to helping people plan for what comes next.

One lender reported that something like a third of people in hardship have gone back to making regular repayments. They've also identified people who will need the assistance to be extended.

Ultimately there's going to be forced to sell, there already are and will be further opportunities in the market for people with funds and borrowing capacity. It's also unlikely to be the bloodbath that some predict.

 

If banks thought having an equity stake in residential property was so great I dont think they would be in the business of lending the money for others to play the game instead.

I think the greatest risk comes from not letting failures and write downs happen in the first place, provided it happens in orderly manner of course.
The worst outcome would be one that just creates a moral hazard whereby failures just cannot happen..... arguably where we already are.

 

Years ago there was an 'equity share' loan available. I don't think any of the majors did it. I don't recall many details but it followed the dinosaurs into oblivion.

 

It did but the Cliff didn’t derail property like it was suggested here.

like most things their is an impact although it’s always the magnitude that’s the variable which is overblown.

 

These loans already Kind of exist. They are called reverse mortgages.
Not sure if anyone still does them or if the RC stamped them out.

My pop needed one when nan got really sick and it served its purpose well at the time. Pop recently sold and the bank took their initial lend and capitalized interest. For them at their age it was by far the best outcome.

However not sure I like it in this scenario.

 

The brutal reality is that people who over-extended into a house they can no longer afford (for whatever reason) are far better off in the long run to face reality and sell.

 

household debt is a reflection of investment properties and not OO properties (RBA paper) and most deferrals are probably investors cause they like IO loans or if possible differed IO loans to maximise tax advantage. of course there could be small size of OO stuck in this situation but surely not the majority. 10% down and slightly up there after could be a real possibility, only based on market fear and not mammoth forced selling.

 

Yes, and not all markets are equal. Lets see how it pans out in 2021.

 

What's being proposed isn't a reverse mortgage, it's joint ownership of the property with the bank.

In a reverse mortgage, as you say, the interest is capitalised and only actually paid when the property is sold. Designed for retires to use the equity in their property when they don't have a real income. They do exist, under fairly strict regulation.

With an equity share proposition, the equity partner owns part of the house, you don't borrow against that part or make repayments on it. As the house grows or drops in value, the equity partner's portion grows or drops correspondingly. When you sell, you receive your percentage (minus whatever loan you have), the equity partner gets their percentage.

It's pretty much the same as buying a house with a friend. You own part, they own part. How much each of you borrows against your part is up to you.

I think this was a pre-GFC arrangement that a few non-conforming lenders offered. It didn't get a lot of uptake and was eventually dropped.

 

At a high level, this is a policy problem regulators were acutely aware of from day one. The financial system risk has been very well recognised by the powers at be, and a range of tools have been implemented.

Theres a number of macro-prudential (& fiscal tools available) to assist in managing this problem:

1. Interest rate cuts ---> this makes the repayment level significantly lower.
2. Interest only loans being allowed more easily --> this again lowers the repayment level significantly.
3. Interest repayment deferrals --> helps borrowers buy time to transition. There's already a 10 month offer for those who seriously need it. This will adjust depending on how Covid19 plays out too.

The above have been purposefully designed to ensure there's a much much smaller proportion of borrowers losing their homes or under severe stress.

The interest rate cuts and offered switch to IO will mean those that are in hardship, have a much much much more manageable equation. If they can't generate their standard income levels because of job losses, the government has shifted the mortgage expense equation significantly. Most of the loans were originated at a stress tested 7.25% P&I repayments. The actual payment amount is around 3% IO, which is very very different.

Nonetheless, there's a substantial amount of borrowers who have their income side of their cash flow completely adjusted, that they'd still be under stress with the lower mortgage expenses noted.

Fiscal policy then kicks in by:

4. Providing large income supports to households. This helps the income side of the equation. This will continue to adjust and taper and respond to current economic conditions. There won't be a sudden move away from income support, it'll be tailored to the economic situation at hand and how well point 5 goes. This will also continue to respond to Covid19 conditions.

5. Growing the economy and jobs again, helping those who have lost income to transition into new jobs.

Once all of the above are exhausted for households, and savings levels are exhausted, there'll be some who are genuinely forced to sell their homes.

Given the targeted, co-ordinated action by governments, the actual number of people in this situation will be far far far lower than what the media scaremongering suggests.

 

Thanks Peter, good explanation.
To be fair I didn’t read the article..I just assumed haha