Market drops 20% what actually happens to mortgages

There has been a fair bit of discussion in other forums regarding downside risk in Sydney at the moment.

Hoping a broker can confirm what / if any mechanism would be employed by bank in below situation.

Purchase price: $1mn (Sydney median)
LVR: 80%, P&I repayments
Post settlement, market moves down and Bank now values property at 20% less (800k).

What if any action would the bank holding mortgage take in this situation? And over what timeframe.

Thanks in advance.

 

Keep making repayments - bank won't be completing valuation.

 

Even in the event of a widespread downturn in a city, a bank will just look the other way?

Multiply that situation by a few thousand clients

Wouldnt shareholders such as foreign owners of AU bank debt be demanding a reclassification of these asset values that the bank holds? And wouldn't the bank then need to revalue those assets vs loans etc.

Banks can't just carry assets on their balance sheet that are knowingly inflated by 20%.

 

With commercial they will ask you to get a valuation
Then ask you to top up the security or increase the principal payments to work towards the correct LVR
If you can't do this then your margin will be increased ...I was told by .4pc

 

Let's take it to the next level. Property value and bank value drops 50%. Therefore real LVR is something like 160%...

But the bank is happy to pretend to market, shareholders, employees etc that rules for 80%LVR still apply and wouldn't bother the mortgagee??

 

What would calling in the debt achieve? If the OO can't afford to pay it all at once, can't finance to another bank (valuation 50%) they'll have to repossess and sell.

Prior to the repossession they had paper losses, after they have actual losses.

 

If prices drop 50% across the board I imagine you and the bank would have other more pressing problems than the current LVR of your loan.

You know - like if you have stashed enough canned food, or if you have enough weaponry to deal with the looters in your neighbourhood.

 

What would the bank do if they take possession?

 

There was at least a 50% drop in some mining towns. I've spoken to a few people who bought in 2011 just before the crash. They've all managed to keep up with their repayments, so the banks haven't taken any action.

It doesn't do the bank any favours to call bad loans if they don't have to. This would only crystallise a loss. As long as the repayments are being made, the bank continues to make a profit. If it takes 30 years, they still get their money back and they still make their originally projected profit.

 

The people who sell in a downturn tend to be inexperienced, recent investors and overstretched builders in new development areas, as that is where a lot of risk tends to accumulate. New property, often partially finished, in new areas with often little development or infrastructure, where each asset tends to have a pretty huge debt against it (obviously in new areas it's rare to see established owners paid up for years on the mortgage)... these new development areas also tend to stack up oversupply because towards the end of a bubble, half of the market are buying to let. So at least half of the buyers of those new assets are holding for profit. Quite a few more are likely to be builders. Essentially you're competing with few hold-at-all-costs owners.

For the most part if you haven't concentrated into these areas, you shouldn't worry about a large market drop. "20%" or even the 50% seen in Ireland is misleading, very much so.

In Ireland maybe 80, 90% of the drop was in new estates because many of them just stalled. Developers slashed prices, investors who'd bought right at the peak couldn't compete and suddenly no one would touch those overbuilt areas with a barge pole.

The rest of the market saw what I'd call a panic drop, maybe 15%, sometimes more, but for quality assets in owner-occupier dominated, established, popular areas the market recovered very fast and presented a fantastic opportunity. So yes there was a "50% drop" but not one that affected most experienced, long-term investors. Also not one that affected most owner-occupiers because the majority just kept paying their mortgages (bankruptcy laws in Ireland are also pretty daconian).

In USA people often seem to have an idea people lost their homes left, right and centre but in reality this was simply exaggerated by the collapse of Fannie Mae and Freddie Mac. Most of USA's crash was just down to inexperienced investors quite rapidly leaving the market (USA still has 'zombie subdivisions' and abandoned estates).

Your job as an investor is to realise market corrections, even large ones, just happen. It's reality. It's not a reason to panic. Look at what you own, make sure it's going to pull its weight in a contracting market, consider what sort of assets you're competing with (if it's mostly new, highly-leveraged investors you might be in a pickle, but if it's mostly owners who'll hold on for dear life then all you need to do is stay rational).

 

It's called negative equity - you owe more than the property is worth.

So long as you keep making your mortgage payments on time the bank usually takes no action.
Marg

 

@Brady had it first time. The bank doesn't re value your house. The banks asset is the mortgage, the payments on that is all the bank is interested in.

Mortgage insurers might be concerned? I'm not sure exactly how insurance works, but I'd think they would be more concerned if unemployment went up, or mortgage stress increased, because again, they aren't insuring the value of the property, they are insuring the mortgage payment.

 

We're in the thick of it up here.

As long as the bank gets paid they do not care.

The problem with negative equity isn't the bank so much but the lack of flexibility that comes with it.

Eg economy tanks, you lose job but can't sell house...

Or you're an investor and would like to move the money elsewhere but can't sell and your rent drops like a stone..

 

What's that saying if you owe the bank $1M dollars and can't pay, you have a problem. If you owe the bank $100M and can't pay the bank has a problem.

If the market fell and the banks started forcing sales it would put more downward pressure on the market and accelerate their own losses. I assume they would be crossing their fingers with the rest of us that any downturn was as minimal as possible to keep the bad debt on their books as low as possible...

 

exactly, imagine if they did? Perth investors would be in a world of pain

 

Good question, worth asking and talking about.

The banks 'assets' are the loans against the properties, not the properties themselves. The loans generate income for banks - which flow through to their P&L. So shareholders do of course care what the loans are backed against, as it does have an impact on the BS & P&L, but not as directly as quoted. So banks don't necessarily need to adjust to do fair value adjustments to the underlying value of the loans if house prices fall. What they end up doing is increasing the default rates on their loan projections, which reduces the value of the loans themselves (because an increasing amount won't be repaid in light of large price drops, and hence aren't worth as much as their listed as).

Different financial markets work differently.

The fact that banks won't call in loans here is one of the reasons why very large price drops are unlikely on a mass scale. Simply, most people won't be forced or incentivised to sell, which is a real trigger point for large scale price crisis around the world.

 

This is not a hypothetical situation, it is reality in Moranbah. What are the banks doing with the loans for houses in Moranbah where the value of the underlying asset has dropped by 50%? This will answer your questions.

 

What are the banks doing on the residential and commercial properties in Moranbah?