Ditch unfair loan margins

Before the coronavirus pandemic, talking about what your house was worth, and how much equity you had, was a national obsession. The same conversation now would be fraught with worry. While we know what shares (and hence KiwiSaver funds) are worth because capital markets remain open, we do not have a functioning housing market. So what houses are worth now, and will be worth in one month, two months, and six months is anybody’s guess.

In one respect this does not matter.

Banks have been effectively told they must behave decently towards customers. They’d probably have done so anyway. Trying to make people sell their homes right now, or trying to hold mortgagee sales, would be a farce, and would force Government to act.

Instead, encouraged by the Government, banks are doing mortgage ‘‘holiday’’ deals, letting people go interest-only on their mortgages, or put all repayments on hold for the time being. By the end of last week, well over 30,000 people had inquired about mortgage holidays at one of the big banks.

In another sense the value of our homes matters immensely. Home-loan contracts go into default if the value of the security asset falls materially.

And homeowners who bought recently could even find themselves in psychologically distressing negative equity, owing more than their house can be sold for.

I recall the horror of negative equity from the late 1980s and early 90s in England. Rising unemployment and interest rates, and an earlier policy-driven house-price boom, resulted in a housing slump that saw an estimated 1.8 million homeowners slip into negative equity.

Unsettling though it was, negative equity was not a problem as long as people’s banks behaved nicely, and they kept paying the mortgage.

The same should be the case here, but there’s an issue of fairness in banking that needs raising now.

When the Reserve Bank brought in loan-tovalue (LVR) restrictions in 2013 in an attempt to cool the housing market, banks responded by charging extra interest to people who wanted to borrow more than 80 per cent of the price of a house.

Margins of anywhere from 0.25 to 1.5 percentage points were added to such loans.

It was a logical response to the LVR restrictions from the banks, allowing them to offer the sharpest home-loan rates to older, safer borrowers.

These extra margins have risen like a spectre confronting borrowers seeking mortgage holidays. Banks have assured worried mortgage brokers they will not charge the extra margins if people are forced to take mortgage holidays, and find that the missed repayments, added to their loans, take them over 80 per cent loan of the value of their homes (or most likely the price they recently paid for them).

That’s only fair. Hitting Covid-19-ravaged households with higher interest charges would be wrong. But that’s not going to seem very consistent to all those over-indebted youngsters already struggling with extra-margin home loans.

If house values today are actually unknowable, and if there are people out there who have slipped into becoming higher LVR borrowers, but are not going to be charged the extra margins, surely the margins should come off those younger borrowers too.

They were led by everyone to believe that once they had served their time on the high-margin home loans, house prices would have moved up, and they would be able to move on to normal home loan rates. That prospect now looks pretty remote.

Banks should recognise that, and remove their extra home loan margins for the sake of fairness.