Curing the curse of negative equity

Via Martin North:

As home prices fall, the risk of households with mortgages falling into negative equity is rising. This has the potential to have significant economic consequences for households and the community more generally. I discussed this with Frank Chung from yesterday who posted an article based on the DFA analysis. As house price falls accelerate, a growing number of mortgage holders across the country are being left in the negative equity “prison”. Today I want to take that forward.

Negative equity is a simple concept, the mortgage you owe on a property is worth more than the current market value of the property. This means that if a household needs to sell, they would be left with an outstanding debt to the bank. And meantime, because of the higher risk, borrowers might potentially facing higher interest rates.

If you are forced to sell, due to a change of circumstances such as the loss of a job, then you are in trouble. Australia has what’s known as “full recourse”, meaning your debt stays with you regardless of your financial situation.

Why is this so relevant now? Well, first forecasts grow darker for how much further the market has to fall, consensus is beginning to circle around the all-important 20 per cent, with 15 out of 21 economists and experts polled by backing the figure.

As they put it, “The reason the 20 per cent figure is so crucial is most lenders require a 20 per cent deposit. If you borrow with a 20 per cent deposit and the price falls by 20 per cent, obviously you’re going to be in equity parity — any further and you’re going to be in negative equity. This is the first time we’ve seen decline forecasts starting to push into negative equity territory.”

Data from APRA, the Property Exposures figures showed that banks wrote nearly 26,000 new mortgages with a loan to value ratio of more than 90%, and a further 51,000 with an LVR of between 80 and 90 percent. That is 20% of all loans written in the same period. I would expect these numbers to fall significantly, as lenders tighten their standards further.

But it’s also worth remembering that in some cases existing borrowers have pulled more equity out to allow them to pass funds to their kids – the so called bank of Mum and Dad, and in the case of a forced sale, the market value may well overstate the true recovery value of the property. Using a property as an ATM does not work in a falling market.

Last month, a Roy Morgan survey of 10,000 borrowers found 8.9 per cent were slipping into negative equity — up from 8 per cent 12 months prior — which would work out to around 386,000 Australians.

We have run our own analysis with data to the end of November and on my modelling currently there are around 400,000 households across the country in negative equity, both owner-occupiers and investors. There are about 3.25 million owner-occupier borrowers and at least 1.25 million investors, so around 10 per cent of properties are currently underwater.

As you know we run a range of potential scenarios, but if our central case works out, with an average fall of 20-25 per cent, our modelling suggests that around 650,000 households would fall into negative equity. My more severe case, if an international crisis hits is for a 40 per cent price fall.

Then you’re getting close to one million households. That would be catastrophic for the economy. That’s analogous to what happened in Ireland where prices dropped 40 per cent. A decade later, there are still people in negative equity who’ve never recovered.

The next question to consider is which households are being impacted. In fact, negative equity is touching “lots of different segments” of the market for different reasons, but collectively it is an “early warning sign” for what was to come.

For example, people in Western Australia who bought at the peak of the mining boom, have seen prices fall by about 15 per cent over the past five or six years. In some locations, much more. So there are pockets of negative equity there.

More recent first time buyers perhaps enticed by first homebuyer grants and those who purchased in the past six to 12 months are now underwater, particularly if they bought new properties. This is because newly built properties are losing value faster that more established ones. It’s like buying a new car, as soon as you drive it off the lot it drops about 15-20 per cent in value.

Then there are the highly leveraged property investors, often with overlapping mortgages. “Quite often we see investors with multiple properties all going underwater. That’s the real sharp end of this.

Meanwhile, investors in places like Brisbane who purchased off-the-plan apartments 18 months ago are now being required to “pony up” and complete the purchase, but the valuation is coming in at 15-20 per cent below the original price. chief economist Nerida Conisbee was quoted as saying that will be a problem for people trying to settle because the banks might not lend them what they now owe, and could also be a problem for the developers.

And it’s not just first homebuyers and investors — people living in expensive suburbs are also feeling the pinch, as prices are falling faster at the more expensive end of the market. We are seeing pockets of negative equity in places you wouldn’t expect to see it, like Bondi and Mosman in NSW and Toorak in Victoria. So there are some more affluent households now suddenly find they’ve got issues too.

Now let’s consider the impact. Most obviously, it means you’ve lost any paper profit you had. In fact, negative equity is a real bother, it really does have a very negative impact on the economy, households and the wealth effect – as prices rise people feel more confident, as they fall, the reverse is true.

As you know we believe the problem has been set up for decades by loose lending. There is a massive overhang of very highly indebted households, this was a correction that was always going to come — the question now is how far and how fast.

Negative equity also causes banks to “get twitchy” because it means they now have a risk on their book, which could cause them to put up a borrowers interest rate. This is because as the risk profile on that loan goes up the banks will probably put some sort of risk premium on the loan, and we already know many households are struggling with repayments because of flat incomes and rising costs. We will update our mortgage stress results tomorrow.

People with negative equity had very few options except trying to pay it off and wait for the market to rise. If you do sell, chances are you still have a loan remaining. History teaches us people stay put. It basically means you’re stuck, you’re a prisoner in your own property. You just keep paying off their loan, though if you are an investor, you may choose to sell and get out before the losses get worse. As distressed sales mount, so prices will fall further.

Banks of course should also reappraise the risks in their mortgage books, and will need to lift provisions accordingly, which will depress profitability, and require them to hold more capital. said that people have gotten used to rising prices, but when we look historically the people that do well are those that hold through down and up cycles. If we look at the worst price crash we’ve seen in the ‘80s, it took about four years for prices to recover. You need to be mindful property is a long-term game, it pays to hold, it doesn’t pay to panic sell. And If you do have an investment property and it’s gone underwater but you have a stable tenant and can afford to pay off the loan, “try and get through this cycle”.

“The biggest problem when prices fall is that we start to see distressed sales when people can’t service the loan,” they said.

I agree that the main thing is “don’t panic”. “If you are not forced to sell and can continue to make your payments, it’s a paper problem and most people will be in that situation. But if you are forced to sell, due to a change of circumstances such as the loss of a job, then you are in trouble. Australia has what’s known as “full recourse”, meaning your debt stays with you regardless of your financial situation.

And reflect in this, a decade after the GFC there are still households in Ireland and the UK who remain in the negative equity trap, with little prospect of property values recovering to pre-crash levels a decade later.

It seems to me the path ahead will be a rocky road, and just how big the potholes will be will be determined by the extent of the falls, and the length of the negative equity trap. As prices are still likely to fall further, anyone thinking of buying now needs to be very careful. We are in for a long haul.

Latest posts by David Llewellyn-Smith (see all)


  1. Excellent assessment from Martin North. But a tragedy that in late 2018 this stuff has needed to be spelled out again and again and still is. The last round of famous property market crashes around the world happened in 2007-8. Spain is an even more severe lesson than Ireland, with much worse unemployment a whole decade later. But they’ve managed to engineer a restoration of housing unaffordability and corresponding perverse incentives for investment, displaying the capacity of humanity for self-deception.

    Note that the highest median multiple at market peak in Ireland was Dublin which hit 6.6. Australia’s two biggest cities are over 9 and the bubble bunnies still think it can go higher! The lesson I have learned about property cycles, is how dam long they can run under increasingly irrational conditions. It’s like crashes don’t come until every last sucker has been lured in by the acceptance that “this IS a new normal”.

    • And for those of us who think ourselves stupid for having taken evasive action some years ago, there may be some solace in the old expression “Better Three Hours Too Soon Than a Minute Too Late.” when ‘sense’ finally kicks in.

      • I didn’t know that one before, that is a goodie thank you. But everyone who bought after a certain point will be in trouble. A historically normal median multiple is below 4. Once the market was above 5, i.e. around 2005 for major cities in this part of the world, you were taking a risk by buying rather than waiting. A proper return to norm should have happened in 2007/8 but dirty tricks were used politically and monetarily to avert this, which has led to far longer-than-usual sustained abnormal high prices. Buying in at the bottom of the small real adjustment post 2008 might have been a good decision, but who knew what was the bottom, and how much worse irrationality was ahead?

        Buying for ownership has probably been a bad decision for most of the last 15 years. People who really understand property cycles and have balls of steel, might well have been buying up investment properties even while wise people did not buy to own permanently, but clever investors IMHO will have started liquidating their portfolios and will be cashed up by this point. A kind of malaise before the proper crash happens, must surely be all that is possible now? Fast bucks in capital gains from adding to the portfolio now – who is this mad?

      • Phil …

        The ‘multiple stretch’ problem is way worse than that …

        Demographia International Housing Affordability Survey: All Editions
        A simple structural definition of an affordable housing market … from


        For metropolitan areas to rate as ‘affordable’ and ensure that housing bubbles are not triggered, housing prices should not exceed three times gross annual household earnings. To allow this to occur, new starter housing of an acceptable quality to the purchasers, with associated commercial and industrial development, must be allowed to be provided on the urban fringes at 2.5 times the gross annual median household income of that urban market (refer Demographia Survey Schedules for guidance).

        The critically important Development Ratios for this new fringe starter housing, should be 17 – 23% serviced lot / section cost – to balance the actual housing construction.

        Ideally through a normal building cycle, the Median Multiple should move from a Floor Multiple of 2.3, through a Swing Multiple of 2.5 to a Ceiling Multiple of 2.7 – to ensure maximum stability and optimal medium and long term performance of the residential construction sector.
        The consequences of reckless and unconscionable disregard for pricing and lending multiples are poorly understood at this early stage of the collapses in Sydney and Melbourne.

        I touched on aspects of this within a recent MacroBusiness Au post …

        It is shaping up to be carnage.

        Clearly … there is just way too much ‘multiple stretch’ in these markets.

  2. Also from

    “House prices crash by 50 per cent, RBA launches $300 billion bank rescue in ‘outrageous’ forecast”

    Its gunna be 60% people. Its already 70% in almost all FIFO and mining / resource towns across Australia – thats hundreds of towns.

  3. “Australia has what’s known as “full recourse”, meaning your debt stays with you regardless of your financial situation.”
    This is mentioned twice, but to my understanding isn’t actually true. Happy to be corrected if wrong but bankruptcy is a financial situation and then your debt goes away, right?
    What full recourse means is that giving up your house to the bank is not all that’s required if you default, they can also chase you for the difference between what you owe and what they sell for.

    • The Financial Ombudsman has the power to release borrowers from dodgy loans and leave it on banks to take the hit.

      Borrowing through SMSFs for housing purposes is also typically of limited recourse. The loans is fire-walled to prevent the bank from raiding other components of the SMSF in the event of a default on the housing loan.

      As always in legal land, these things are complex. Just as the USA was not all jingle mail (no recourse), despite the popular rhetoric, Australia is also not all full-recourse lending.

      • Med, from what I’d read about SMSF property loans is that the banks have (for a long time) taken personal guarantees that makes a non-recourse loan a moot point.

  4. DefinitelyNotTheHorribleScottMorrisonPM

    Only loser geeks worry about negative equity. Everyone else thinks it’s the same as negative gearing and so must be great for a fat tax deduction. This is a particular strength of the Australian market.

    • So if the value of your house falls, you get to deduct that amount from your taxable income? That would be great policy.

      This way all the go-getter mums and dads who tried to get ahead with guaranteed double digit annual gains and, through no fault of their own, bought the top of the market, can share their pain with the rest of the layabouts.and perma-renters who have crashed the market with their lifestyle choice not to participate.

  5. Thank you Martin North.

    I don’t think people realise how personally catastrophic negative equity is. Holders can’t sell. They cant take a better job in another city. If family circumstances change (a birth, a death, divorce, teenagers need a room each, young adults move out, grandma needs to share) the dwelling cant be exchanged or extended.

    All the while, repayments are above what others are paying for equivalent dwellings and well above rents. Don’t get sick. Don’t lose your job.

    Have a look at Zillow’s chart of US NE here:

    I chose this report simply as it is a decade after 2007. It shows NE peaking at 31.4% of households with mortgages and 10 years later, 10.4% are STILL in NE, STILL trapped paying more – even though interest rates fell, house prices recovered and incomes rose in aggregate.

    Can’t happen here? Martin estimates 400,000 Australian households are in this position today. Further major price falls are certain for all the reasons this site outlines in detail. NE is set to rise dramatically as each stage of the price correction flips a larger proportion of mortgaged household balance sheets negative.

    Underwater households cant breathe. No-one can hear them scream, Thrashing around only consumes oxygen faster.

    Put yourself in this position – for a decade. The daily reflection and regret would be poisonous.

    Don’t Buy Now!

    • The last paragraph talking about effective negative equity( those who can cover the bank loan but not a new deposit/taxes related to sale and purchase/ real estate fees after selling their residence) is pretty startling. The percentages of trapped population goes up dramatically.
      People in that situation have the rental market option,but it would still be a deterrent to moving on.

  6. The point at which negative equity becomes a problem is even a bit sooner than Martin states given that transaction costs of 4-5% are typical and often added to the mortgage.

  7. And for those who believe in the “It doesn’t matter if house prices fall! You are buying and selling in the same market”
    IT DOES.
    Anyone who has a $1 mil. house today with an $800k mortgage that want to move up to that $1.5 mil. place on the harbour, and decides to wait, could find that with a, say, 50% correction that the new pace is $750k and the old place is $500k, with $800k owing. To move they will have to give the bank back $200k just to get back within the 20% deposit guidelines.
    Negative equity stops the mobility of the market stone dead….

    • That’s a good point for those in debt Janet. How will it affect debt free boomers? A bit of denial before acceptance of a lower price before the seachange & then trying to squeeze those towns to maintain a spending margin?

      • Good point. This will put a floor under the price of the kind of properties favoured by retiring baby boomers, i.e. harbour/beach apartments, sea/tree change locations, small acreage just outside major cities. There might even be some pent-up demand, i.e. people who originally intended a sea change 5 years ago, but decided to wait longer while their house went from 1.3mil to 2.2 mil. Today they might only get 1.7mil, but this will still be enough to make the move and live comfortably afterwards.

      • For the debt free, downsizing is worse than upgrading in a falling market. This is because the dollar price difference between the two properties reduces. Downgraders have left cash difference left over. Upgraders need comparatively less extra money to fund the upgrade.

        The difference is more still if you sell before you buy (and in a falling market you’d have to be pretty brave to buy before you sell!).

  8. Perth’s four-year housing bust is nothing like what Sydney and Melbourne’s property markets face – ABC News (Australian Broadcasting Corporation)

    As house prices continue their downward trajectory on the eastern seaboard, property owners across the Nullarbor are watching on with interest

    Perth is more than four years into a housing downturn that is yet to bottom out after median house prices peaked at $585,000 in November 2014, according to Landgate figures. … read more via hyperlink above …

  9. I’ve read a few comments above echoing the sentiment wrt Negative Equity that it locks people in (Don’t get sick Don’t lose your job, Dont…..) Makes it all sound like average punters have some control, as in here’s a list of things you shouldn’t do ….Having seen a few recessions in my time (and restructured one biggish company during a recession) I can say with some certainty that your average worker is not in control of their personal outcomes. Their job doesn’t somehow “belong” to them. It comes as a huge shock to many good little worker bees when the board is looking at falling earnings with plummeting net free cashflow and hires ahole (like I used to be) who turns up and tells whole divisions of the company that they’re fired. I’ve lost count of the number of times I’ve received emails or worse still talked with people that were fired often after working 20 plus years for a company.
    My point is that it is often not something that even the most diligent worker has any control over, if the whole division is losing money big time and has little future growth potential than someone somewhere will make the logical decision to shut-it-down the rest is just necessary execution of said plan. Lot’s of workers think that they’ll get rescued by another division but in most cases that just won’t happen because you can’t lower expenses by simply reallocating labour, someone just has to go, to avoid any possible charges of discrimination (sex age race…) the HR people will advise management to just shut down a whole division, (as in don’t rescue anyone) because each lifeline you throw creates an opportunity to prove that you are actually discriminating.
    Bottom line: the directive to not lose your job is cute but probably useless advice.
    BTW Don’t get sick is also cute advice. When your house is in NE and you lose your job, pretending this won’t make you sick is also kinda delusional.
    I know things are different in Australia but in part that’s because Australia simply hasn’t seen a significant recession in over 1/4 of a century. Lets see how different things really are when our systemically important companies are fighting to survive themselves.

    • BTW Don’t get sick is also cute advice. When your house is in NE and you lose your job, pretending this won’t make you sick is also kinda delusional.

      Seeing a colleague of mine show up to work each day in Ireland after his apartment lost 80,000 euro in value (a figure I thought huge at the time), and he was in a stable job. He just looked sick. Bags under his eyes, stressed, unable to move job or country for another opportunity. I really felt sorry for him. I was glad it wasn’t me. I know I’d be sick with all the stress. I spend a lot of time avoiding stress in my life. I don’t want it/need it.

      I just don’t think Australian’s are going to cope well in a downturn, too soft after so many years of prosperity. When I got here I bought a Suzuki Jimny since it was 1.3ltr, small motor and cheap to run. I have been preparing for winter for ages, renting a dump to save money. A novel idea in this country (to save). Even I’m worried how this will go.. I’m thinking even $100-$200k of debt is not good.

      • Oh it’s real this kind of stress kills people.
        I had one friend, lost his job, lost his house, lost his wife, kids thought he was a looser, one day he just loaded his Nine with Hollow points and went out with a bang!
        Had another friend, similar situation, but he decided to work harder and get through it. In the end he had 1 full time and 2 part time jobs, he just wasn’t sleeping, looked worse each time I saw him, than came the somewhat expected news that he drove off the highway and into a ditch. The medical expenses crippled him, six months later he died of a massive heart attack aged 38.
        This kind of stress doesn’t just make you sick, it can kill you!

  10. I think many people are posting don’t get sick, don’t lose your job knowing these are risks but not truly understanding what this means. I got sick (just a series of viruses) one winter when I was stressed over work while overseas and ended up with chronic fatigue syndrome. That’s a death sentence to the life I would have led. I can see the housing downturn making what would have been an illness that would have been recovered from into something that won’t. The stress of having our debt levels that have never been this high combined with falling house prices will kill lives that would have lived even if death isn’t involved. And we haven’t even got to rising interest rates or the external shock that has to eventually come. Maybe there is one last leg up in the market before those two events happen, and that will be the true bear market trap. People will also look back at that as their best and last opportunity to exit if it comes and they didn’t take it and probably self destruct in all sorts of negative emotions.

    • Good point about Stress induced illnesses
      I’d go as far as to say that All Autoimmune disorders are stress activated.
      I’ve seen plenty of otherwise healthy people find themselves in high stress situations and quickly develop illnesses like Type 1 Diabetes (as in youth diabetes developing in a middle aged man) It’s a type of diabetes that’s now called Type 1.5.
      Similarly I’ve seen colleagues develop Rheumatoid Arthritis and fibromyalgia way more often than should happen with random occurrence of these disorders.
      What’s interesting is that the body often never recovers from these Autoimmune disorders, once triggered they’re with you for the rest of your life.
      As you say that’s a heck of a price to pay: being in constant pain from RA for the rest of your life all so that you can keep up with the Jones.

      • Stress can cause so many knock on issues. At times of high stress I’ve found I’ve had more allergic reactions to certain foods etc.. I’ve also found you can develop different skin conditions / rashes etc.. I don’t think all of stresses impacts on the human body are well understood and it’s long lasting effects.

  11. But I do have a question (will also ask on weekend links)

    If your PPOR profits are CGT free, then can you claim PPOR capital losses against other capital gain? Obviously not other income, God forbid.

    I know you can claim for investment capital losses against other capital gains (and hold losses over).

  12. Concerns about a housing-led spending slowdown in Australia are growing — this chart explains why | Business Insider

    Concern about the outlook for household spending — the largest part of the Australian economy — are intensifying following soft growth in the latest national accounts.

    This chart from Macquarie Bank is unlikely to help appease those concerns. … read more via hyperlink above …

  13. Now would be a great time for:
    – State governments to transition from Stamp Duty to Land Tax for all new purchases.
    – Federal gov to impose carbon tax that is redistributed in full to all but top 15% households on a per capita basis.
    – Payroll tax slashed or abolished.

  14. Diogenes the CynicMEMBER

    I saw a lot of negative equity situations whilst living in Hong Kong. Property market crashed hard one year by 70% and even though Hong Kong had much better/safer lending deposit rules in place (it was 30-50% deposit) many people were in negative equity. As they lost their jobs or had wages cut they struggled to make the payments and some looked for a permanent exit via life insurance, there were stories about people jumping off buildings and in front of trains on the MTR. It was a very strange environment but taught me never to gear up into property so I haven’t. Moving places might be stressful but it is all over after two-three weeks, unlike negative equity. Moving also teaches you not to buy too much useless junk/excess stuff as you’ll only be discarding it at some point – buy quality and take care of it.