Sucking out the equity

by Bernard Hickey / 05 September, 2016
Bernard Hickey breaks down the Reserve Bank’s loan-to-value ratio (LVR) controls and their role in the housing market.
The Reserve Bank’s second round of loan-to-value ratio (LVR) controls introduced in November last year were aimed at slowing lending to Auckland rental property investors.

But limiting the LVR for these people to 70% didn’t mean they had to have a 30% deposit. There was an important clause called the “combined collateral exemption” that allowed many Aucklanders to keep borrowing to buy more rental properties, particularly outside Auckland.

It worked like this: a bank could lend more than 70% of the value of an Auckland rental, or more than 80% of a non-Auckland rental, if the combined value of the loans for all the landlord’s properties, including the one they lived in in Auckland, was no more than 70% or 80% respectively.

For example, an Auckland home owner living in a house in Auckland and owning two Auckland rental properties saw their equity rise from $540,000 in June 2012 to more than $1.56 million by mid-2016 because of the 85% rise in house prices over that period.

This table shows how a property owner with equity of $540,000 has been able to borrow against that to capture capital gains of $231,000. If prices increase by a further 20% over the next two years, those capital gains will reach $870,000.
This table shows how a property owner with equity of $540,000 has been able to borrow against that to capture capital gains of $231,000. If prices increase by a further 20% over the next two years, those capital gains will reach $870,000.


That home owner could then leverage that Auckland equity to buy rental properties in Hamilton and Tauranga for a combined $988,000 and hope that another 20% rise in prices by 2018 would generate another doubling of that equity. The two properties were effectively being bought with 100% mortgages, but this was possible because the combined collateral exemption meant the combined properties had LVRs that met the respective 70% and 80% LVR limits in Auckland and beyond (see table above).

The Reserve Bank has proposed keeping this combined collateral exemption for the new nationwide 60% LVR limit for investors, which means Auckland and other landlords will still be able to suck the equity out of their own homes and spread it around with some leverage to buy other properties. The faster property prices rise, the more power that leverage has.

Brokers have also noticed the exemption will stay. “The bank will let you go up to 80% on your owner-occupied property and up to 60% on your proposed rental property, so basically a combined collateral exemption lets you soak up your equity in your house up to 80% and then use that as your 40% deposit,” says Campbell Hastie of Go2Guys Mortgage Advisers.

“If there was no exemption, they would probably be letting you go to 60% on your owner-occupied house and 60% on your rental property, and that gives you less horsepower than your exemption currently allows.”

However, Loan Market’s Bruce Patten reports some banks are requiring investors to use the profits from the sale of one property to pay down the mortgage on other properties in their portfolio to bring them to the new 60% maximum debt level.

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