What does negative equity mean?
Negative equity occurs when the value of real estate property falls below the outstanding balance on the mortgaged used to purchase the property. It is calculated by taking the current market value and subtracting the mortgage.
It leaves home owners in the unfavourable position of not being able to sell, or selling an asset and still being in the red.
How widespread is the problem?
The RBA suggests that the problem is mainly in Australia’s north and west, where mining has played an important role in the local economy.
Following the mining boom in Western Australia, almost 60 per cent of loans are in negative equity, with similar data coming out of the Northern Territory, the Reserve Bank of Australia (RBA) said in it’s April reporting.
While officially the number is 2.75 per cent of mortgages being in a state of negative equity, the RBA states that some private surveys estimate the figures to be closer to 10 per cent of mortgage holders in Australia.
Investors should note that these surveys are likely to overestimate for a number of reasons, including not accounting for offset account imbalances.
The impact on Sydney and Melbourne
Sydney and Melbourne housing prices are expected to decrease further in the current year. With this, the RBA warns that negative equity could increase in Australia’s two largest cities.
The RBA suggests that around 1.25 per cent of loans by numbers or 1.75 per cent by value are likely to move into negative equity if there are further housing falls.
Compared to the international experience with negative equity, the RBA suggests the incidence of negative equity is likely to remain low.
The peak of the GFC in 2012 saw over 25 per cent of properties in the United States move into negative equity. In Ireland, the numbers reached 35 per cent, as trough prices falls exceeded 30 and 50 per cent, respectively.
Even if negative equity becomes more common in the larger housing markets of Sydney and Melbourne, the impairment rates for banks are unlikely to increase significantly while interest rates remain low and employment remains high.