One million Aussies could become ‘prisoners’ in their own home as falling prices put them in negative equity

As house prices across the country plummet, Aussies from all walks of life are terrified of these two words.

As house price falls accelerate, a growing number of mortgage holders across the country are being left in the negative equity “prison”.

Borrowers in negative equity find themselves paying off mortgages for more than their properties are worth, unable to sell without being left with an outstanding debt to the bank, and potentially facing higher interest rates.

As 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 Finder.com.au backing the figure.

“This is the first time we’ve seen them agree with those kinds of figures,” said Finder.com.au insights manager Graham Cooke.

“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.”

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.

Digital Finance Analytics founder Martin North estimates the figure is higher. “On my modelling currently there are around 400,000 households across the country in negative equity, both owner-occupiers and investors,” he said.

“There are about 3.25 million owner-occupier borrowers and 1.25 million investors, so around 10 per cent of properties are currently underwater.”

Mr North’s base case for the housing market is average falls of 20-25 per cent, which would push 650,000 households into negative equity. His worst-case scenario, which assumes an international crisis like another GFC, is for 40 per cent price falls.

“Then you’re getting close to one million households,” he said. “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.”

WHO IS AFFECTED?

Mr North said negative equity was touching “lots of different segments” of the market for different reasons, but collectively it was an “early warning sign” for what was to come.

People in Western Australia who bought at the peak of the mining boom, for example, have seen prices fall by about 15 per cent over the past five or six years.

At the other end, many enticed by first homebuyer grants who purchased in the past six to 12 months are now underwater, particularly 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,” Mr North said.

Then there are the highly leveraged property investors, often with overlapping mortgages. “Quite often we see investors with multiple properties all going underwater,” he said. “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.

“That will be a problem for people trying to settle because the banks might not lend them what they now owe,” said Realestate.com.au chief economist Nerida Conisbee. “That 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.

“You’re seeing pockets of negative equity in places you wouldn’t expect to see it, like Bondi and Mosman in NSW and Toorak in Victoria,” Mr North said. “There the more affluent households now suddenly find they’ve got issues too.”

WHAT DOES IT MEAN?

Most obviously, it means you’ve lost any paper profit you had.

“Negative equity is a real bother, it really does have a very negative impact on the economy, households and the wealth effect,” Mr North said.

“The problem is this 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 your interest rates.

“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,” Mr North said.

“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.”

Mr Cooke has experienced it first-hand, having purchased an apartment in Ireland in 2008 around the peak of the real estate boom.

“That particular property has only recovered in value to around the cost of the mortgage now so many years later,” he said. “It can leave you trapped. I moved to Australia but wasn’t able to sell the property.”

WHAT SHOULD YOU DO?

If a borrower goes into negative equity, the best thing to do is stay put and try to keep paying off their loan.

“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,” Ms Conisbee said.

“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.”

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,” she said.

“We’re not yet at that situation. That typically happens is when we start to see rising unemployment. But it is possible we may start to see some panic selling if they think the value of their home or investment starts to drop rapidly.”

Mr Cooke said people with negative equity had very few options “except trying to pay it off and wait for the market to rise”.

Mr North agreed, saying 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,” he said.

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.

“Unlike in the US where you can just hand the keys back and walk away, the banks have you by the short and curlies,” Mr North said.

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