Rupert Gough: What would happen to your mortgage if the housing market crashed?

COMMENT: Lately, concerns from the Reserve Bank have centred on how exposed recent low-deposit home buyers would be to issues if the property market had a sudden and sharp correction. For the purposes of this article, let’s call a market crash a drop of 20% from market highs.

Before we go any further, I don’t think this is a likely scenario. I predict a flattening of the market for a number of years with some small price fluctuations around the various areas of New Zealand. Some may drop a little, others, unbelievably, may continue to rise. But with any investment - and homeownership is an investment even if it’s your own home - it’s worth understanding the risks. Hope for the best but plan for the worst.

Obviously, in this 20% market crash scenario, anyone who has recently purchased with less than 20% deposit may have an underwater mortgage, meaning they owe more on their mortgage than their house is worth. There are a few things to remember in the event this happens:

1: If you continue to make your payments, the bank doesn’t care if your mortgage is underwater. Banks won’t force a sale of a house just because the house is worth less than the mortgage. In fact, this would be a terrible strategy for the banks as that would lock in the losses whereas allowing a homeowner to continue to pay down their mortgage will solve the problem over time.

2: There are a number of ways to value your house - useful websites like OneRoof or registered valuers, etc - but your mortgage is only truly underwater if you can’t find a buyer for more than you owe. In other words, your mortgage could be underwater on paper but there may be a buyer out there that would pay a premium for your home. The only way to truly know if you have an underwater mortgage is to list your home. This leads us to our next point.

3: Being underwater is only an issue if you need to sell your home. It is certainly a risky position to be in, for instance, if one of the homeowners loses their job for a reasonable length of time, but if you are planning to stay in your home for a long time then there is no reason to have a knee-jerk reaction to being underwater (especially if it’s only on paper).

The first point is probably the most misunderstood concept. The banks would be crazy to call in a mortgage that is underwater when the owners are continuing to pay the mortgage. For anyone who is oblivious to values, an underwater mortgage would continue as normal.

So should you purchase with values already having gone up so much? Those looking to purchase “quick flick” properties may want to reconsider unless they are very experienced or have a coach for guidance. But if you are planning to live in the property for a decent length of time, eg; more than five years, you could still purchase and focus on some of the things that reduce your risk from a market downturn.

The primary goal should be to get your property to a loan to value ratio (LVR) of at least 70%-75%. This should have been the goal for any low-deposit borrower at any point in the past; it’s just that the market tended to solve the problem for you rather than focussing on how you can achieve it.

Without continued capital gains growth, there are two ways you can achieve this goal: make extra payments on your mortgage or improve the value of your home through renovations. Which of these you choose will depend on your individual property; some properties benefit greatly from renovations. Reducing the amount you owe on your mortgage is always worthwhile particularly as we enter a time of increased interest rates. If you do choose to renovate, be aware that the digital valuations (those using aggregate data from your neighbourhood) don’t know you have renovated and may show you as being more at risk of being underwater than you actually are.

Buying a house when discussions of market downturns are prevalent always feels a little strange but if you are sure it is a long term purchase and you know you can either pay your mortgage quickly or improve the value of your home (or both!), then consider still looking for properties within your budget.

- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.