Podcast: 3 Scenarios That Would Make the Market Go Berserk | Ep. 208

Posted by Ed McKnight on 21/04/20
3 Scenarios That Would Make the Market Go Berserk 001
Listen to the Show

Listen to the Show

Show Notes

What's Covered in the Show?

In this episode, we discuss a recent blog written by Ed with 3 speculative scenarios that would make the property market heat up.

These are:

The maximum mortgage term lengthening from 30 to 35 or 40 years The bank's test interest rate falling from 7% to 5%, and The LVR restriction for investors of existing properties relaxing to 75%

In each scenario, we also walk through the quantifiable impact that would have on home buyers ability to borrow.

We also mention the Opes Partners Instagram. Every few days we release a new carousel post that teaches you something new about the property market.


Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show we're talking about what would make the property market go berserk.

Now, this is a really interesting topic because it's based on a blog post that I just wrote over the weekend. Where. I was thinking back to something that Tony Alexander said on the show where he said, look, a lot of the house price inflation that often happens has been caused by long-term structural changes. Now, these structural changes are sometimes factors or events that are very hard to predict. So I'm talking about rapidly decreasing interest rates. I'm talking about high net migration or the massive lack of new supply, new housing supply that's not being coming onto the market over the last couple of decades in New Zealand, and all of these structural changes have added a lot of heat into the property market.

Now we're going through a pretty unprecedented time at the moment with Coronavirus and policy makers are rewriting the rule book. They're experimenting with unconventional policies, and so I started to imagine three different structural changes that that could move in the financial sector. They would actually add a lot of heat into the property market. And so we're going to go through these different scenarios and talk about, well, if the government did this policy or undertook a specific policy or course of action, what would that impact or how would that impact the property market?

So the first scenario is if maximum mortgage terms were extended. So at the moment, the longest term you can get a mortgage on is about 30 years. Well, it's not about 30 years, it is 30 years, but when mortgages were first coming out, they were actually only five years. That was back in 1917 or so. And they were structured very differently. It wasn't until the new deal came out from President Roosevelt in America that the maximum mortgage term was extended to 30 years.

So what if the government came out and along with the reserve bank said, actually we're going to allow the banks, now that we're living longer now that we're working longer to extend those mortgage terms to 35 or 40 years, what impact would that have? Well, if you currently were able to get a loan for $500,000. And the repayments that you could afford is about $3,300 which would be the minimum payment over 30 years. If the loan term was extended to 35 years, you could afford to borrow an extra $21,000 and if the loan term was extended to 40 years, you could afford an extra $35,000 so extending the mortgage term that makes them a mortgage term would have about a 4% to 7% difference.

And the amount of lending that a borrower could take on in order to buy a house, and they would have some impact on house price inflation. So, so what's interesting here is that even extending the mortgage terms doesn't really have a massive structural difference. It might have if you add an extra 10 years on there, an extra 7% borrowing ability but it's not going to be massive. So that's why we started looking at scenario two. Andrew, walk us through scenario two and what that would mean for the property market.

Andrew Nicol: So scenario two is the situation where, your test interest rate drops, sorry test interest rates for anyone that hasn't listened to our podcast on how banks assess loans, a test interest rate is a rate above the actual rate that banks use to work out if you can service the loan or not, or how much of a loan you can service. Now, generally speaking, it's a couple of % above what the actual interest rate is.

Now the reason for that is because banks want to be sure that you can service this loan based on today's rate but then also if the rate goes up as well. Now, as I say, normally, historically it has been a couple of % above maybe what a normal two year or three-year interest rate would be, now that's not the case at the moment. There's a big gap between what the actual interest rate is and what the banks test rate is and in some cases it's significantly more than double. So banks are normally using a test interest rate of about 7% at the moment.

So what that means is when you go to apply for a loan, they're going to look at the loan that you're applying for, work out what the what the repayments are on a 30 year term at 7% and approve it based on whether or not you can afford it at that rate even if you're fixing at 3. Now let's say that the bank's look at us and say, well, we can actually afford to bring that test rate down. And I think this is probably very realistic. Let's say they drop that down to say 5%, so a 2% decrease from 7% to 5% turns and they assess the loans or affordability at 5%.

Now. If you had a $500,000 mortgage on a 30 year loan term at 7% your payments per month would work out to be $3,326. Now if that test rate drops to 5% those same repayments, $3,326 a month can be used to afford a loan at $620,000 so a huge difference 24% more purchasing power. Now, if you coupled that with an extended term of 35 years, that drops up, sorry, increases to 660,000 and if it goes to a 40 year term that increases to $690,000 purchasing power based on the same repayments of $3,326 a month. And that's an increase of 37.97% so that makes a huge difference on someone's purchasing power if they're applying for a loan.

Ed McKnight: And I think that some of these scenarios are reasonably realistic, especially the test interest rate changes. And you can imagine a scenario where the government comes out and says hey let's, try and help first home buyers in the best way we can do that is to allow them to borrow more and change the financing rules and just buy making some of these small tweaks, you can have quite a large impact on the property market.

And now I just want to walk through scenario three, which I think has probably the most likely as well, which is that we have a relaxation of the loan to value ratio restrictions. So at the moment, investors require a 30% deposit in order to purchase an existing property, one that already exists. But what would happen if those were relaxed to 25% so we didn't get rid of them completely. We didn't say, well, now you only need a 20% deposit like owner-occupiers do. We said no, investors, if they want to invest an existing properties, they need to have a 25% deposit, which is still five percentage points more than everybody else. What impact would that have?

Well, actually, it's much bigger than you'd think. And the reason for that is that whenever you relax the LVR restrictions, especially for investors, the it's, it's a, it's a bit of a double banger if I can use that turn of phrase. And the reason it has a double impact is not only does that mean, that investors can borrow more with the same amount of deposit, so they've got more purchasing power. What it also means is they can borrow more against their existing properties. That might be a, at 70% loan to value ratio, so they can borrow more against their existing properties and pull out more of a deposit.

Because the way a lot of investors get their new deposit for their next property is they borrow more against their existing properties as they go up in value. So they're effectively recycling the deposit is the term that's often used. So the double impact is, you can borrow more for the same amount of deposit, but you also have a larger deposit cause you can borrow more against your existing rental properties.

So let's say that you're an investor. You've got a property worth 550 K and you've got a 300 K mortgage against that. Now, under the 70% LVR, you could, you would have what we call usable equity. You'd have a recyclable deposit of $85,000 within that property. Now, if you change that, just decrease that LVR, to 75% so allowing people to have a 25% deposit, you could now borrow an extra $112,500 against that property. So you've got extra deposit of about $30,000 within that property, just under $30,000. So you've got extra deposit, but also your borrowing capacity increases cause you can borrow more using that increased deposit.

So this investor in this situation, instead of being able to borrow a total of $283,000 for their property, they would now have $450,000 to go and purchase a property with, which is an increase of almost 60% purchasing power. And this person would actually be able to go and buy an extra property, because you probably could do that with $450,000, but you probably couldn't with 283. So if we had a relaxation of these LVR rules investors specifically investors who already have properties or are looking to go and purchase other existing properties, these people would have a lot more purchasing power and would be able to go and be much more active in the market, which would really heat it up.

Now, the one thing I do want to say is it doesn't really matter. The purpose of this exercise going through these scenarios is not to say, well, these are all going to happen because they probably aren't all going to happen and certainly not all at once, but what this does is imagining potential scenarios, whether they eventuate or not, they help us to understand what could potentially happen in the future, what sort of structural changes could happen in the future to kickstart the property market and particularly the, the decrease in test rates and the decrease in LVR restrictions, those are all really realistic and in fact, the LVR restriction is a, it's being mooted already and has been over the last year that these would decrease because the LVR restrictions were only temporary measures anyway, but there are a whole heap of other structural changes as well that could occur, that would add additional heat.

And just thinking about these scenarios allows us to think, well, what might happen. Anything else to add there Andrew before we, we finish it up.

Andrew Nicol: Just one other point that I noted in your blog post Ed, which everyone should read because it is great. One thing that I hadn't considered is that, the government has some extra power because they own Kiwibank and if they got Kiwibank to make some of these changes first, that would put pressure on the other banks to follow suit. And I do think it's very probable that the test rate will change, and I do think it's very probable that LVR restrictions will be eased in the next wee while. So, small adjustments can had big impacts on the housing market. So whilst there are some negative factors right now, there is a lot of positive factors and I think there's more to come.

Ed McKnight: Fantastic. Well, let's wrap it up there, but please don't forget to rate, review and subscribe to this podcast. It really does help us get the message out to more people and hey, if you want to learn more about property, why not check out the Opes Partners Instagram, we're very active on Instagram and are constantly posting every two days or so, we'll post a new update that we create based on a new piece of data we've found or a new article we've written.

So I'm going to link that into the show notes as well as I'm also going to link up this blog that we've been talking about in this podcast episode, so just tap or swipe over that cover art, it'll take you right there.

Thanks for listening to the Property Academy podcast. I'm your host. Ed McKnight, and I'm Andrew Nicol, and we're going to be back again tomorrow even more daily strategies, tactics and insights to help you get the most out of the New Zealand property market.

Until next time.