Wheeler explains why loan-to-value ratios were introduced
Reserve Bank governor Graeme Wheeler explains why he introduced restrictions on low deposit lending.
Friday, October 4th 2013, 12:20PM 4 Comments
Many New Zealanders consider purchasing a house to be a rock solid investment, and assume that house prices will continue to rise steadily, having never seen a bear market or experienced rapid rises in mortgage rates.
Over the past 25 years, however, many wealthy countries have experienced periods of substantial decline in house prices.
Falling house prices erode homeowners’ equity, while mortgage lenders experience losses on their loan portfolios. The resulting stress in the financial system can have long lasting adverse effects on the economy. For borrowers, it can mean years of spending cut-backs to rebuild savings. The greatest impact is on borrowers, often first-home buyers, who recently entered the market with the least equity. In the United States, real net household wealth for the median household fell 39 percent from 2007 to 2010, and a quarter of America’s mortgage holders owed more on their houses than what their houses were worth.
Our concern is that excessive increases in house prices in parts of the country, if unchecked, pose increasing risk for the financial system and the broader economy. High and rising house prices increase the risk and potential impact of a major correction in house prices, and consequential loss to lenders. In a severe downturn, such losses would be expected to significantly reduce banks’ willingness to lend. Similar views about the risks from our overvalued housing market are expressed by the IMF, OECD, and the major international credit rating agencies.
New Zealand’s house prices are expensive, based on international comparisons of house prices relative to rents and to levels of household income. And our household debt levels relative to disposable income – having doubled over the past two decades – are also very high.
Could New Zealand experience a sharp fall in house prices? While not anticipated, our economy is not immune to such risks. The world economy still faces major challenges and, if global growth slows markedly, or if China’s financial system experiences major difficulties, it would quickly feed into the New Zealand economy and housing market.
House prices are rising rapidly in Auckland and Christchurch for two reasons: housing shortages and easy credit. It is critical that issues around land availability, zoning restrictions and high building costs are resolved and that the housing targets in the Auckland Accord are achieved. It is also important that credit expansion is restrained to be more in line with housing supply. Restricting lending to borrowers with low deposits can help reduce the upward pressure on house prices, especially as banks have been competing aggressively for borrowers with low deposits – with this borrowing accounting for 30 percent of new mortgage lending.
Some suggest that loan-to-value restrictions should be applied regionally, especially around Auckland, or that we should exempt buyers of lower-priced houses. We considered both options. However, regional restrictions would be hard to administer and would shift housing pressures outside wherever the boundary is drawn. Exempting low-priced housing would be a recipe for rapid increases in the cost of such housing. Broad exemptions to other groups such as first home buyers would substantially undermine the effectiveness of the restrictions in reducing house price inflation.
While new for New Zealand, such restrictions have been introduced in 25 countries, and are currently being deployed in Canada, Israel, Korea, Norway, Singapore, and Sweden. Most countries adopting such restrictions prohibit high loan-to-value lending. We have opted for a more flexible approach, which still allows banks to do some high loan-to-value lending. Nor should such moves be seen as permanent. Restrictions will be removed when there is a better balance in the housing market and less risk that their removal will reignite high house price inflation.
While the Reserve Bank’s mandate is to promote financial stability, there are clear implications here for housing affordability. Over the next two years interest rates are likely to rise in order to restrain an expected increase in broader inflation pressures. We currently expect that the official cash rate could increase by 2 percent from 2014 to the beginning of 2016. This could result in interest rates on first mortgages of 7-8 percent. If the loan-to-value speed limit is unable to slow house price inflation, larger increases in the official cash rate would be required.
We are keen to see house price inflation moderate significantly and, in doing so, reduce the risks to the financial sector and the broader economy. Speed limits on low deposit lending are designed to help achieve this. Loan-to-value restrictions are expected to give the Reserve Bank more flexibility as to when and how quickly we have to raise interest rates, but the more fundamental solution to reducing pressure in the housing market lies in addressing the issues around housing supply.
« LVR restrictions 'could spark complaints' | Banks' interest margin up » |
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Comments from our readers
If not how does penalising them affect the market overall? I would have thought that in Auckland first home buyers would be lucky if they can afford a garage! Should they be lucky enough to scrap together a deposit and buy a house they are then going to be hit with mortgage interest rate increases in the next couple of years. Not looking very promising for them.
This 20% LVR is particularly unfair for provincial towns which have still not started to recover from the recession and where young first time buyers are now condemned to renting or leaving town just so they can make enough money to start their savings (wages are much lower in the provinces.) Mr Wheeler quotes the futility of applying different rules to different parts of the country as it will jsut drive up prices elsewhere but he is likely quite ignorant of the reality of small towns who are struggling to keep their residents from leaving to go to the city or hop off to Australia. Im not suggesting giving these towns preferential treatment - but rather stop punishing them for Auckland and christchurches excesses. By making these satellite towns more affordable for first time buyers, you are saving them from extinction and also getting people out of the cities and back into the great little communities that the country is built on. Thames is a great example of a town where values have suffered due to job losses - however if it was attractive enough to purchase a home on a lower mortgage, people would be able to commute and also give life back to the town. Stop punishing the rest of the country - just focus on the auckland market (and the overseas investors that are the real problem)and Christchurch which is facing a unique housing problem which has absolutely no bearing on the rest of the country.
Singapore has a 40yr+ proven system for first time home buyers, and has since built over 1 million flats. suggested a similar system (not the building of flats) to an mp, who shown no interests at all and she boasted national's scheme, which has sold how houses since? that's the trouble with politicians, they think they know everything and don't have to listen to any of us.
When quoting other countries' example, info you should not cut and paste to suit your action.
You are welcome to ask me how the singapore system works if there is any interests at all. or you can spend tens of thousands of dollars of tax payers money and send a contingent up there.
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This would restrict access to local and non-resident speculators with a non- permanent residence status.