Negative Equity

inSight

11 Oct 2001

Negative Equity

Earlier this week the HKMA announced modest measures that should enable banks to be more flexible in refinancing mortgages for property owners in negative equity.

There is no doubt that the subject of negative equity is a highly emotional one. When you sit in what is supposed to be your "home" and it is worth less than the amount of money that you have borrowed, secured upon the property, it is difficult not to feel lousy. Although the decision to buy a home was entirely yours, you have reason to feel aggrieved because, you are told by what you read in the news, that the sharp downward adjustment in property prices was the result of shifts in the government's housing policy. So, you conclude, the government, at least in part, is to be blamed and the government should do something to look after you.

Regardless of the validity of this argument, there is, and should be, a great deal of sympathy for the many members of our community who have found themselves in the difficult position of their own homes being in negative equity. Regardless of the validity of this argument, it is commonly accepted that the government has a responsibility to look after members of the community who find themselves in difficulty. But this must be subject to the important proviso that whatever is done should not undermine the long-term interests of the community as a whole.

Let me focus on mortgage lending, which is an important issue to us as the supervisor of the banking system. It is in the long-term interest of the community that the banks exercise great care in the management of the risks of the largest component of their loan book. A failure to do so by a bank may adversely affect its profitability and undermine the confidence of its depositors, to such an extent as to affect its viability. Banking problems are highly contagious and may therefore undermine the general stability of the banking system. This will jeopardise the interest of depositors and the efficiency with which the banking system performs the role in intermediating funds - a role that is essential to facilitating economic growth and development. This is why we have the 70% mortgage policy that has served us well over the years. This is why we have the guidance on debt-to-income ratio for mortgages. This is why we emphasise so much the need for banks realistically to assess the risks of their loans. This is why we keep such a close eye on mortgage lending. If it had not been for this collection of policies and guidances, the problem of negative equity would now have been much, much worse.

But, of course, not all mortgages in negative equity are so risky as to justify the charging of significantly higher interest rates. If the debt-to-income ratio of a borrower is fairly low and if the debt servicing record is good, the risk involved, it can certainly be argued, is not significantly higher than that for a mortgage that complies with all the guidelines. This is, of course, a matter for the lenders to judge, on the basis of information specific to borrowers available to them. But our attention has been brought to the plight of the many worthy cases that have been prevented from taking advantage of the competitive environment among banks to refinance their mortgages at lower interest rates. This was specifically attributed to our policy on 70% mortgages. Thus, a mortgagor in negative equity to the extent of having a loan-to-value ratio of 110% would need to come up with a repayment of 40% before he or she can refinance the mortgage at a more competitive mortgage rate.

We have a lot of sympathy for these cases, even in our capacity as banking supervisor with a keen interest in sustaining the profitability of banks. The simple reason is that, taking a longer-term view, the access of these families to lower interest rates would increase their ability to continue to service their mortgages through and beyond the upturn phase of the economic and property cycle. Depriving them of this access may indeed increase the risk of their defaulting, as they persevere through the current period of difficulty. We have therefore introduced an exception to the 70% mortgage policy and allowed the refinancing of mortgages in negative equity to be exempt from it, but on the condition that the refinanced amount does not exceed the value of the property. The mortgagor with a loan-to-value ratio of 110% will now need to come up with only 10% (instead of 40%) to have the mortgage refinanced at a lower interest rate.

We hope that this is helpful. But the extent with which those in negative equity will benefit from this depends on the willingness of the banks to refinance them, and the final decision has to be taken by the banks on the basis of the merits of each case. Incidentally, this does not mean an end to the 70% mortgage policy. The arrangement applies only to mortgages in negative equity, which in any case already exceed the 70% guideline of loan-to-value ratio. New mortgages continue to be subject to the guideline. And the arrangement also has the added advantage of enabling the banking system as a whole to reduce its exposure to mortgages in negative equity.

Joseph Yam

11 October 2001

Related HKMA Circular:

Related Press Release:

Click here for previous articles in this column.

Document in Word format

Latest inSight
Last revision date : 11 October 2001