What would make the market go berserk?
Andrew Nicol discusses three different potential lending structural changes as a result of the Covid-19 crisis.
30 April 2020
Coronavirus has pushed us into unprecedented times. Policymakers are rewriting the rulebook and experimenting with unconventional policies. It’s not unimaginable that structural changes could flow into the property market.
That’s why we’re going to imagine three different “structural change” scenarios and their impact on the property market.
The Maximum Mortgage Term Increases From 30 To 35 Or 40 Years
In an attempt to help first home buyers get into the property market, the Government, in partnership with the RBNZ, encourage banks to extend the maximum loan terms given to young New Zealanders. Instead of paying off their mortgage over 30 years, the Government considers proposals to lengthen this time to 35 or 40 years.
The Impact: increasing the loan term from 30 to 35 years would increase the amount a first home buyer could borrow by 4.14%. If a first home buyer could afford to borrow $500,000 on a 30-year term, they could now afford to borrow $520,697.
Increasing the loan term from 30 to 40 years would increase borrowing ability by 7.06%. The first home buyer who can afford a $500,000 mortgage now could afford to borrow $535,298 over a 40-year term. They could use this extra borrowing ability to bid up house prices.
The Test Interest Ratefalls From 7% To 5%
As interest rates continue to fall, the rate property buyers actually pay, and the “test” interest rate used by banks when assessing mortgages get more and more out of whack. Although interest rates nudge below 3%, mortgage applications are still tested at 7%.
If the Government aligns with the Reserve Bank and through the government-owned Kiwibank decreases the mortgage test rate to 5%. This increases the number of first home buyers Kiwibank attracts, expanding the company’s profits. The four main Australian banks, feeling the commercial pressure follow suit.
The Impact: if a prospective home buyer can currently afford a mortgage of $500,000 using the 7% cent test rate, they could now afford to borrow $619,667 using the 5% test rate. That would allow all property buyers to take on 23.93% more lending. Similar to the above scenario, first home buyers use the additional lending to enter the market, bidding up house prices in the process.
The Deposit Required For Investors Through The Lvr
Restrictions Are Eased From 30% To 20%
In our final scenario, which is now on the table, the Reserve Bank, realising it needs to bring confidence to the New Zealand economy post the Covid-19 shutdown, relaxes the LVR restrictions.
The Reserve Bank governor releases new rules that allow investors to purchase existing properties with a 20% deposit, down from 30%. The new policy has a double impact. Not only can investors borrow more with the same amount of deposit, but the change also gives investors larger deposits as investors borrow more against their existing properties
The Impact: an investor with a property worth $550,000, which has a $300,000 mortgage secured against it, can borrow $85,000 against the property under the existing LVR rules. As the rules are relaxed, she can now borrow $140,000 against this property to fund the deposit for her next investment – a 64.7% increase. She now uses this larger deposit to borrow more money, and purchase a property worth $700,000.
Under the previous rules, she could only purchase up to $283,333. The new rules allow the investor to borrow $416,667 more – a 147.1% increase.
When I first wrote this article, these scenarios were purely speculative. We’ve now found that the RBNZ is progressing with the third scenario. Any combination of these policies would add significant stimulus to property buyers, which would heat the market and increase house prices.