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A bubble is building that could shake our economy to its core – or could we manage it sensibly…?

Please refer to the Article: Aussie Housing Bubble

For simplicity lets consider a theoretical pre-bust home value of $500k with a maximum loan ratio of 80%... the original loan was $400k… now lets say after a 30% devaluation the above home is now worth $350k... so post event the original loan ration is now 114% of valuation.

I believe the real impact of such an event is primarily dependent on the Banks/Lenders response… ie: do they:

  1. a) …call in their capital to ‘adjust’ the mortgage lend ratio risk exposure back to the 80% maximum or
  2. b) ...allow the mortgagees to continue to repay their original obligation if they so choose without loan ratio adjustment until the property is next sold.

I believe this is the fundamental difference in terms of the ultimate impact if and when this occurs.

In scenario a) which is what I understand was the general case across the USA after the GFC - I receive a call from the bank saying my lending ratio is now beyond the agreed value and I need to pay down my $400k loan to the 80% of the new property value ie: $320k therefore, I need to find $80k overnight.

Clearly this would be a position of significant stress for most families today and and as occurred in the US result in an extreme rate of 'automatic’ default. Banks end up with huge volumes of foreclosures which further decrease the value of their fire-sale house stock... clearly this scenario works for no one.

Under scenario b) the mortgageee continues to pay the original obligation under the original terms... the housing market will certainly slow due to the debt to equity ratio becoming less viable for some but this effect would be somewhat offset by the lowering of prices across the market. Some with low debt to equity ratios would still be in a position to upgrade whilst others would choose to sit tight and repay their original obligation.

Option b) might leave the banks more exposed for a short period… but at least when considering the family home (and the unique nature of that investment as more than a simple economic transaction), I question in the longer run if option b) would not be a more lucrative approach for all…?

Any informed professional feedback as to any other side effects or impacts also, what the likely response from the major Aussie lenders might be, would be appreciated.

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