Do full recourse home loans make Australia immune from a housing crash?

The tune of Jingle Bells is probably still stuck in your mind in the days after Christmas. But around this time a decade ago it was "jingle mail" that was starting to get attention in the US.

Jingle mail is the term for home owners who simply hand the keys to their house back over to the bank when they can't afford their mortgage repayments.

It's an especially attractive option if property prices are falling and the borrower is in negative equity (where they owe more than their home is worth).

The main reason many Americans can do this and Australians can't is the existence of non-recourse home loans in the US.

A non-recourse loan means the bank only has access to the home the mortgage is on to recover any outstanding debts — it can sell the property to recover as much as it can, but can't access the borrower's other savings or assets.

Such loans don't really exist in Australia, where the standard mortgage contract gives the bank full recourse — if you default the bank can not only sell the property, but also get a court judgment to go after your other assets and even send you bankrupt.

Many property market analysts cite this as a key difference that makes Australian real estate less likely to crash in price.

If the outcome of missing your mortgage payments is losing pretty much everything you own and being declared bankrupt, the theory goes that you will do just about anything possible to keep paying your home loan.

But a common misconception is that all US mortgages are non-recourse — this is completely wrong.

In fact, a large majority of states allow banks recourse on mortgages.

This has allowed Associate Professor Andra Ghent, a real estate economist from the Wisconsin School of Business, to analyse the effect that lender recourse has on default rates.

"Borrowers in non-recourse states are 32 per cent more likely to default than borrowers in recourse states," she concluded in a 2011 paper co-authored with Federal Reserve Bank of Richmond researcher Marianna Kudlyak.

"Thus, the data allow us to reject the hypothesis that recourse has no effect on default."

The effect of lender recourse on default rates only increased with the value of the homes — for homes worth more than $US500,000 default was more than twice as likely in non-recourse states.

External Link: Recourse and residential mortgage default

This appears to back the theory that Australian borrowers are less likely to default on their loans because their bank will go after their assets, and it isn't even the full picture.

"US personal bankruptcy laws are very generous relative to most other industrialized countries," Dr Ghent told ABC News.

"Thus, this makes even recourse mortgages in the US more like partial recourse relative to those in other industrialised countries."

Australia potentially 'less sensitive to home price shocks'

So, given most Australian homes are in that higher price range and the banks here have even more powers to go after your personal assets if you don't keep up your mortgage repayments, the effect here is likely to be stronger in reducing defaults.

This should have a stabilising effect on home prices in a severe downturn, given that other research cited by Dr Ghent has found that a foreclosure reduces the value of the home by more than a quarter, due to the effect of the forced sale and the lender's desire to sell the property as soon as possible.

This is the conclusion reached in a separate research paper by Dr Ghent's colleagues, Dean Corbae and Erwan Quintin, also from the University of Wisconsin-Madison.

"Economies in which recourse is broad and cost-effective in practice may in fact be less sensitive to aggregate home price shocks."

However, the effect is not as big as you might think because banks are more likely to make riskier loans when they have full recourse.

"While each loan is safer because of recourse, the pool of borrowers changes to allow more low-income and low-asset agents to enter," the researchers added.

"The net result on default rates is a decrease of about 10 per cent."

It's a conclusion Dr Ghent said makes sense.

"If lenders have full recourse, you may see them making higher LTV (loan-to-value ratio) loans which would tend to increase house price volatility," she told ABC News.

That's because bigger loans allow for higher home prices when the market is on the way up, and the bigger they are the harder they can fall.

And there's much more to default rates and housing crashes than recourse versus non-recourse.

"An interest-only loan, an ARM (adjustable rate mortgage), or a purchase mortgage raises the probability of default," Dr Ghent noted in the 2011 research.

"Loans with a high LTV at origination are more likely to default. Finally, younger loans are much more likely to default than older loans."

It is little surprise then that Australia's Reserve Bank and the bank regulator APRA have been pushing to first see a decline in loan-to-value ratios and, this year, a large decline in the amount of new interest only loans being written.

"Combining recourse mortgages and LTV limits reduces the default rate while boosting housing demand," wrote researchers Juan Carlos Hatchondo, Leonardo Martinez and Juan M. Sanchez in a 2015 paper.

"Together, they also prevent spikes in default after large declines in aggregate house prices."

Does that make an Australian housing crash impossible?

So does all that mean that a housing crash is impossible in Australia?

Not really. Ireland's property calamity dwarfed the US housing crash in terms of price falls and economic fallout for the nation, and it has very aggressive full recourse mortgages.

Real estate lawyer Anthony Joyce has helped many Irish renegotiate their loans, reach a settlement on their defaults or even sue their banks for lending malpractice.

He wrote on his blog earlier this year calling for Irish law reform to switch from full recourse to non-recourse home lending.

"We now have a chance to change our culture to one where the bank has to be concerned about the value of the property and not just the individual's capacity to repay the loan," he said.

"This would cause the banks to ensure that they are not lending into an overheated property market."

That is, of course, unless the banks can package up the mortgages and sell them to someone else who then carries the default risk, as they did in the US before the global financial crisis.

Where there's potential profits to be made, it seems there's generally a way around any rules designed to protect consumers.

Original Article

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