Just over a year ago I blogged about Loan to Value Ratios (LVRs) and home deposits.

At that time the Reserve Bank’s Deputy Governor, Grant Spencer, was opening thinking about an LVR cap of 80% – requiring every house buyer to save up a minimum deposit of 20%.

This blog concluded that such a blunt tool was unfair and inappropriate:

One size doesn’t always fit everyone, or every condition. Sure, the current system is not perfect – but no system is. Many benefit greatly from paying a higher deposit. Others ought to be talking to their bank about getting one of those low low mortgage deals available now.

This year’s Budget carried the announcement that the government and Reserve Bank had signed a Memorandum of Understanding aimed at addressing risks to the housing market, and wider economy, as they emerged. You can read the whole thing here.

This blog shall focus on explaining the one weapon that’s been deployed already – the recently announced restrictions on LVRs – and detailing why they

a. Don’t work all that well, and

b. Hurt first home buyers most unfairly.

The lower quartile price (a typical target for first home buyers) for a house in March 2013 was $280,000. This could get you a three bedroom, 190m2 house in Hawera…

…or a two bedroom unit in Weymouth, Manurewa.

What’s this new rule about?

The new LVR rule is what Gareth Vaughan describes as a “speed limit” rather than an outright cap. From 30 September the big four banks (BNZ, ANZ, ASB and Westpac) will be required to set aside extra money to protect themselves should those ‘high risk’ loans of more than 80% go belly up.

What’s the impact?

Banks, like any other business, aim to maximise profit. So this extra cost will be passed on to the mortgagee via a higher interest rate. Fewer people buy, demand for housing drops a bit and the market cools down a little.

Everyone is happy. Except first home buyers, who this change will hurt the most.

This group will have to choose between paying thousands more in interest now, or save thousands more for a higher deposit later – at which point they’ll likely be facing much higher interest rates anyway.

All in favour?

Barfoot & Thompson likes it as it could protect buyers from borrowing more than they can afford. The Federation of Family Budgeting Services largely agrees, having seen cases where some mortgagees have borrowed large and saved small. This Bay of Plenty Times editorial also sees the real estate market as a threat, despite that region’s average housing performance.

These arguments come from a well-meaning place. Like we said last year, however, many benefit financially from getting on the ladder now while interest rates are low. Force them to save more and many won’t be able to buy and will just give up and do something – or go somewhere – else.

LVR restrictions have failed in the past

Upon retirement, former Governor Alan Bollard gave an interview to Bernard Hickey where he described LVR restrictions as “the least desirable of the [options] we might look at.” When tried in the 1970s, distortions arose as people found their way around the rules. Indeed, it was what helped give rise to a number of our finance companies (remember them?).

Additionally, as Bollard pointed out to The Listener, in the old days people would get loans approved for their pets to circumvent the rules. On this basis alone Gareth Morgan should be opposed to LVR restrictions; his plan to have cats trapped and executed is already facing stiff opposition. With a capped LVR he would first have to cause these cats to default on their mortgage payments, then sell their homes via mortgagee sale, forcing them outside, and then have them trapped and executed.

The Reserve Bank is ready for war on high house prices.

Those with low deposits are already paying higher interest rates

Check out the handy mortgage rate comparison chart on Interest.co.nz. There you’ll find different rates depending on whether you’re fixing, floating, living in a Christchurch red zone or – and here’s the point – the size of your deposit.

The BNZ homepage right now is advertising a rate of 4.95% for those with at least 20% saved up. Westpac offers a rate ten points lower for those with an LVR of less than 80%.

If there was an issue with high LVRs, the banks identified and accounted for it some time ago.

Are high property prices the fault of first time buyers?

Not really.

We have a shortage of supply, not an excess of demand. They’re not exactly one and the same; as we said two weeks ago Auckland is building nowhere near enough houses to keep up with population growth.

Punishing those on the bottom rung of the ladder won’t do anything to get more houses built.

Enough theory – how are real people affected by this?

The media have found some examples of how LVR restrictions will hurt real people.

Mark Bell, a 22-year-old apprentice builder from Hamilton, has to save twice as much for a house now. Meanwhile, Hamilton house prices have dropped 4% since April 2012.

The Nogaj family of Tauranga reckons it’ll now take them 20 years to save up a deposit despite Tauranga’s median price dropping from $343,000 to $327,500 in a year.

The common thread? People all over New Zealand are being punished for what is an almost exclusively Auckland/Christchurch problem.

Euon Murrell, Wellington region spokesman for REINZ, described the new rules as “a complete overreaction to a situation that’s been stumped along by Auckland and Christchurch.” His home region of Wairarapa, with an average house price in April of $246,000 (see page 14), is one of the most affordable regions in the country. Same rules will apply to them as in Auckland.

This graph shows how much change there’s been in house values since the 2007 market peak. It’s very easy to see where much of the growth has taken place.

What do you think?

Are the new rules fair or are they picking on the wrong target? Regardless, will they dampen prices? And does your cat have time to catch mice AND deal with mortgage brokers? Let us know in the comments or over on Facebook.