60% LVR? What was the Reserve Bank thinking?

Earlier this week, RBNZ announced that as of 1 September 2016 there will be a requirement for loans to residential property investors to have a minimum of 40 percent deposit. Basically, this means the maximum LVR can be 60%. The Reserve Bank expects the banks to follow the regulation as soon as possible.

What does this mean for existing property investors who have a LVR higher than 60% (ie have less than 20% deposit)?

Good news. The regulation won’t be applied retrospectively, meaning investors who already received a loan won’t be affected. The regulation only applies to new loans being originated by the banks.

What has been the reaction so far?

I contacted a representative of the country’s biggest mortgage lender, ANZ and found out that ANZ has decided to honour existing pre-mortgage approvals but any new loans for property investment will require a minimum of 40 percent deposit.

The other Big 4 Banks, Westpac, BNZ and ASB all plan to apply the Reserve Bank’s minimum deposit regulations effective immediately. With regards to pre-approvals, the banks may have some discretion and will generally decide on a case by case basis.

Why did the Reserve Bank implement stricter lending requirements?

The RBNZ’s intention was to slow down the growth in house prices and prevent the housing market from overheating. They could achieve the same effect by raising interest rates but the Reserve Bank argues that higher interest rates make negatively affect the economy. If you look back into the banking history, you will know that in the 1980’s interest rates were in the double digits like between 10% and 15%. The current mortgage interest rates of 4% to 5& are very low by historical standards.

What could be some unintended consequences?

2 major consequences stand out:
Firstly, foreign investors are not affected. Why? Because most banks already have restrictions on lending to foreign investors (such as not recognising foreign sourced income and limiting the amount of loans made to foreign investors) As the Reserve Bank only regulates banks operating in New Zealand, nothing stops foreign investors borrowing money from overseas banks to invest in New Zealand. Just look over the ditch at Australia. When Australia applied a similar LVR rule, the proportion of local investors in new housing dropped (Apparently in Australia, foreign investors can only buy new housing but unfortunately we don’t have this rule in New Zealand). At the same time, there was a dramatic rise in the proportion of foreign investors buying new housing in Australia. Almost a third of new housing residential property investors were foreign investors. Effectively, requiring a higher deposit, only reduces the number of local & marginal property investors but leave foreign investors generally unaffected.

Secondly, those who are not currently on the property ladder will find it increasingly difficult to get into the real estate market. Homeowners still have to come up with 20% deposit for their own home. Assuming a house price of $600,000, you still have to come up with $120,000. How many renters have $120,000 sitting in the bank (and earning a piddle interest of 3% mind you)? The gap between those who own property and those who don’t will increase.

What’s next?
If you look back 50 years of the property cycle, you will find that when property prices double from their last peak, we have reached the top of the current property cycle. As pointed out by Ron Hoy Fong, prices have doubled since their 2007 peak. Sure. There may be been overshoot in prices but the market always come back to equilibrium (The one thing I learnt from behavioural finance is that over-reaction always occurs). Just a side note, beware of forecasts from experts specially those from Bernard Hickey. He’s been saying the property prices will fall since 2012. I think he was five years out.

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