Week in Review
Bad Things Happen: the first home buyer tax
A special Newsroom series scrutinises products and practices that some in banking would rather went under the radar. And we crunch some numbers on what this lack of scrutiny is costing us, the banks’ customers. The series takes its name from a warning by Financial Markets Authority chief executive Rob Everett that "bad things happen" when no one's regulating banks.
Today, in Part 1, we look at low equity premiums (LEPs) - the banks' first home buyer tax that's raking in millions.
A man walks into a bank. Ouch.
A first home buyer walks into a bank, takes out a mortgage with less than 20 percent equity and then can't or doesn't contact his bank every month or so to check he’s on the right interest rate. That’s an oversight which could be costing him an additional $1,000 a month on his mortgage, or $12,000 a year. Ouch ouch.
A lot of mortgage holders, mostly first home buyers, are in the same situation with their banks, all paying too much interest every month because the bank should have recalculated their equity position, but hasn't. In this case, the hit is into the millions. Possibly as much as $100 million of unjustified fees being paid by homeowners to their banks - every year. Or as much as $500 million that banks have overcharged their mortgage customers since 2013. Ouch ouch ouch.
At best it's a story of bank apathy; a failure to invest in the technology which would make sure customers were paying the right interest rate every single month. At worst, it's a deliberate decision by banks to maintain a status quo that rips off customers and benefits banks. Oh, and it also prevents the very thing the government is trying to promote - first home buyers getting into homes. That's because banks charging people more than they should rules some people out of the market.
If you have taken out a mortgage since 2013 and didn't have a 20 percent deposit, the chances are you have been affected. Check your documents.
To begin at the beginning.
What exactly are low equity premiums?
Low equity premiums (also known as low equity margins) are fees charged by banks to customers - very likely to be first home buyers - who want a mortgage, but have less than a 20 percent deposit. In bank-speak, these customers have less than 20 percent equity in their home. Hence a "low equity premium".
Three out of four of our Australian-owned banks - ASB, Westpac, and BNZ - charge the low equity premium as an additional percentage added onto the interest rate. ANZ does it as a one-off fee at the beginning of the mortgage. That works out best for customers. Kiwibank used to charge a one-off fee too, but scrapped it at the end of last year.
With the other banks, the size of your low equity premium is worked out as a sliding scale, depending on how much equity you have. At Westpac, for example, it's 0.25 percent if you have 15-20 percent equity, 0.75 percent if you have 10-15 percent, 1.5 per cent extra if you have less than a 10 percent deposit, and up to 1.75 percent for people with the lowest amount of equity. That’s a lot of extra money on a sizeable debt like a mortgage.
In addition, low equity first home buyers end up being charged even more because they aren’t eligible for any special interest rates that might be offered to other customers.
Altogether they might well be paying a 2 percent higher interest rate on their mortgage than someone not being charged the LEP. On a $500,000 mortgage, it could add up more than $5000 extra a year, or $10,000 over a couple of years. And the higher the mortgage, the more you pay.
The Aussie-owned banks say they need to charge a low equity premium (LEP) for customers with not much deposit, because there is more risk the customer will default. If that happens, the bank could lose out, particularly if house prices go down.
Banks also argue that Reserve Bank capital rules - introduced to make our banking system safer - make lending to people with low equity more costly. Banks say the LEP is necessary to cover those additional costs.
Certainly the first part of that argument is correct - it does cost banks more to lend to people with low equity because of the Reserve Bank requirements. And it's true that low equity premiums were introduced after October 2013, when the RBNZ introduced its new regulations around banks' lending under 20 percent equity.
However, the Reserve Bank does not require banks to charge their customers an LEP - that's a decision the big four banks make. And the other side of the argument is that banks are charging arguably their most vulnerable mortgage customers, first home buyers with low deposits, a higher interest rate on their mortgage, to cover the RBNZ costs.
It's worth remembering that New Zealand's big four Aussie-owned banks made $5 billion profit last year. Five billion dollars. These banks are some of the most profitable in the world, for their size.
Moreover, Newsroom sources close to the banking industry insist that even without the LEP, the banks would still be making plenty of money on their first home buyer, low equity, mortgage customers.
Coming off the LEP - or not
Actually, whether banks should charge an LEP or not is only part of the story. More worrying is what banks do - or rather don't do - about getting their customers off the low equity premium,or onto a lower interest rate bracket.
In theory, as soon as a customer’s equity goes above 20 percent they no longer have to pay the low equity premium. At the same time, they should also be eligible for any special offer interest rate the bank is giving their other customers.
And that could happen quite quickly for a customer, particularly when house prices are rising, because then their debt will be a smaller proportion of the overall value of the house. At the same time, the LEP will also be impacted as the customer pays off some of the principal.
But in practice, banks often keep on charging the low equity premium for months or even years after that magic day when the customer’s equity rises above 20 percent.
And that’s because the bank doesn’t know when that day is. Their technology systems, which seem able to work out within hours if a customer goes into overdraft, don’t automatically alert them to a change in that same customer’s LEP status. And if the customer doesn’t ask, the banks sure as hell aren’t going to proactively do the maths.
Instead they rely on customers coming to them to ask for a re-calculation. Or until there’s a mortgage “event” - the end of a fixed term contract, for example, or if the customer wants to borrow more money.
Ignore your mortgage at your peril
Trouble is, many customers are busy, or slack about their finances. They trust their bank will make sure their charges are fair. So for one reason or another they don't talk to their bank about their low equity premium. Probably they forget about their LEP altogether. It’s on their loan documentation, but so is a lot of other stuff.
It’s human nature. People put the contract in a drawer, pay the premium, and wait for the bank to be in touch.
That could be an expensive mistake to make. Depending on the term of someone's loan, it could be two, three or even five years down the track before their LEP gets reviewed, meaning they could be paying extra interest the whole of that time.
And that’s a big difference. Newsroom calculates that someone with a $1 million mortgage and less than 10 percent equity will be paying an additional $1000-$1200 over what they should be paying every month that they don’t notice they've gone below the 20 percent cut-off.
That’s $12,000-$14,000 a year.
If they have 15-20 percent equity, the difference will be $5000-8000 a year.
And they won’t get that back.
Newsroom calculated these numbers for BNZ, ASB and Westpac, which charge the low equity premium as an additional percentage interest rate. With ANZ, which charges a one-off fee but adds it onto the mortgage, the number is smaller - between $3400 and $4500 a year, depending on the amount of equity a customer has. Kiwibank doesn't charge an LEP, although customers with less than 80 percent equity pay 0.75 percent more than those with a bigger deposit because they don't get the bank's special interest rate.
The banks argue they are upfront about the low equity premiums/margins. And that’s right. Newsroom contacted the three banks involved - ASB, BNZ and Westpac. We approached them as a customer wanting a low equity loan.
All the bankers mentioned the premium, but said it was up to us to request a recalculation, particularly if we wanted it to include an updated house valuation.
Don't ask, don't get
Take Westpac’s answer, sent through by email following a phone conversation. Westpac calls it a "low equity margin" and says it can be up to 1.75 percent on top of the base interest rate. In theory, the LEP/LEM would decrease as the equity in the house increased.
“However, the low equity margin does not decrease over time on its own," the email stressed. "Unless you request us to update the LEM via an updated property valuation, the LEM will remain in place."
The banks told Newsroom that customers mostly have to pay for their own valuation. Given that might cost several hundred dollars a pop, that's an added disincentive for customers to keep checking their LEP position.
Westpac continues: “The LEM also cannot be removed/reduced if your loan is fixed. LEM can only be removed/reduced once a loan is floating. A good time to address your LEM is when you discuss your Fixed Rate Rollover with us.
“Calling periodically to check the valuation of the property is a way to circumvent LEM if the account is floating at the time," Westpac says. "If you purchased a $500,000 property with a $50,000 deposit and three months later the property was valued at $600,000, technically your equity would now be $150,000/25 percent - aka LEM can be removed if the account is floating.”
Note this is only going to happen if you are on a floating interest rate - and only 20 percent of us choose a floating rate.
And it's only going to happen if you ask.
Using our calculations with the Westpac example, we would have paid an additional $11,500 by the end of a two-year fixed term.
It’s a similar situation at ASB and BNZ.
ASB told Newsroom it performs both manual and automated reviews of customers’ low equity margin positions.
“Manual reviews occur on customer request, any time six months after draw-down,” the bank says. “Manual reviews use the current loan balance and a revalued property value.”
Customers pay for that revaluation.
ASB does its automated reviews monthly, although not until one year after the customer took out the loan. And, critically, the automated reviews use an updated loan balance, but don’t change the value of the property. And that matters - a lot.
One hell of a difference
We got the calculator out again.
Imagine you bought a house in Auckland in 2013, the year the Reserve Bank’s restrictions on bank low equity lending came in. To make the maths easy, we’ll say you have a $1 million loan. Your house is worth $1.14 million, so you have only 12 percent equity. That’s low equity premium territory, and according to our calculations you’ll be paying somewhere between $8000 and $11,000 more per year than you would have been without the LEP.
That’s pretty shocking. But it gets worse, as this table shows.
If your bank adjusted your LEP annually using just your mortgage repayments (as with the ASB automated review scenario), it would have taken you four years - until 2017 - to lose your LEP and go back to the interest rate charged to everyone else. That’s around $40,000 of LEP-related additional payment. Money you won't ever get back.
If, on the other hand, you had been proactive and presented your bank with a revised house price valuation, you would have already been under the LEP threshold by the end of the first year of your mortgage. Of course, that's assuming your bank allows you to be proactive so early in the mortgage term.
But you could have saved yourself up to $30,000
It's similar for 2015. Using the same loan on a house in Auckland, but adjusting only for what capital you repaid, it would have taken until this year - 2019 - to get below 80 percent.
But taking the house prices into account, it takes just one year to get over the line.
It's worth noting these calculations use Real Estate Institute NZ’s average property price increases for Auckland. Growth hasn’t been the same in other places, though some smaller centres have taken off recently.
The Reserve Bank calculates that 7 percent of the country's $256 billion-worth of mortgages are taken out by people with less than a 20 percent deposit. But in 2013, that figure was closer to 20 percent. That's potentially thousands of customers paying way more than they should over the past six years.
I certainly thought it was unfair to whack on a premium. I was a bit shocked. I wasn’t more likely to default than I had been before.
Barney was lucky - he reckons he paid only a couple of thousand dollars more than he should have. He had been a banker for six years, and he was pretty clued up.
Barney took out a mortgage to buy a house with his then girlfriend in 2015, but when they split up and he bought his ex-partner out, the new debt took his loan below 80 percent equity. His bank, BNZ, slapped on a low equity premium. He tried to bargain, but no chance: “They pretty much tell you what your interest rate is when you are in a low equity position.”
But Barney was pissed off. “I certainly thought it was unfair to whack on a premium. I was a bit shocked. I wasn’t more likely to default than I had been before.”
He’d also worked in banking for a while, so he knew the ropes. When BNZ recommended he call regularly to check on the status of his premium, that’s exactly what he did. He rang every couple of months. And each time he asked about the valuation. Within six months, his low equity premium had been removed, he says. He probably paid an extra couple of thousand dollars - but not more.
“If I hadn’t been so peeved about them adding the premium, maybe I wouldn’t have been quite so aggressive about asking for an update. Then I would have been charged until the next time they re-fixed my home loan.”
Does he think banks should call customers, not the other way round? He certainly does.
Dream on, says Sam Stubbs, managing director of KiwiSaver provider Simplicity - and no friend of banks.
“I’ve never heard of a bank proactively re-assessing rates when they hit a higher equity level. And I’ve never seen a [bank IT] system that allows that to happen."
Banks are hoping for apathy and ignorance
New Zealand banks have all the information they need on what principal customers have paid on their mortgage, practically on a daily basis, Stubbs says. Yet they don’t use that information to reset someone’s LEP level, unless they get asked. They certainly don’t link that mortgage payment data with up-to-date house valuations, despite those being readily - and relatively cheaply - available from companies like Quotable Value or Valocity.
“If you ask the bank ‘Will my rate change if I go over 20 percent equity?’ they will say 'Yes, let us know when it does and we’ll change it.’ But it won’t be automatic.”
It also won’t be backdated to when you actually hit that critical 20 percent equity number.
No bank is going to be making a celebratory phone call to their first home buyer customers on the day they achieve what should be a magic milestone, Stubbs says. No "Well done guys, you've achieved 20 percent. Crack open the bubbly". It just isn't going to happen.
“Banks are hoping for apathy and ignorance.”
Stubbs seems to imply the banks are deliberately not proactive. Without being a fly on the wall in bank boardrooms, it’s impossible to know if this is the case. But what seems incontrovertible is none of them are prioritising investment in systems which automatically and immediately switch customers to the right LEP bracket, or out of LEP altogether.
And that’s benefiting the banks - big time. Or costing customers - whichever way you want to see it.
Big cost to customers
We crunched some more numbers trying to work out what the total impact of incorrectly fixed bank LEPs might be - and even we were shocked.
There’s no way that 100 percent of all customers paying low equity premiums at any one time shouldn’t be paying them. But what if it’s 25 percent? That’s $75.6 million being paid by customers to their banks each year - unjustifiably. Even if it’s only 10 percent, that’s still almost $30 million each year.
You might argue $30 million is a lot for customers, but it's a drop in the ocean for banks. The Big Four Australian-owned banks made more than $5 billion in profit last year, making them some of the most profitable in the world per head of population.
But critics of the banks say these big profits come from a poorly-regulated banking system, where no one’s checking whether bank products and fees are fair. Add up a whole lot of small, potentially unjustified charges and that helps get to the big money that banks make.
No justification for LEPs
Valdimar Einarsson is one of those critics. Born in a tough rural community in Iceland - the sort of place “where you either survive or die” - Einarsson worked in rural banking in New Zealand for 20 years, before getting out of the industry.
Now he runs New Plymouth-based agribusiness accounting and consulting company AgriMargin, and has some strong views about bank conduct - including about low equity premiums.
Not only is it unreasonable to keep charging higher interest rates beyond the date when the LEP should be removed, he says, but banks shouldn’t be adding LEPs at all - certainly not using risk as a justification.
“LEPs are not a good thing - full stop. The equity associated with a loan is not a good measure of the success or failure of a loan.”
It's true that the Reserve Bank makes banks hold more capital against low equity loans, which does come at a cost. But what makes Einarsson angry is that one of the banks' main arguments is that low equity premiums are necessary as a way to price in the higher risk they say comes from low-deposit loans. The banks say they want to guard against not getting their money back.
But Einarsson argues that each mortgage decision is an individual one - it's the banks assessing the likelihood of a particular customer not paying back the loan. When a bank loses money on a loan, it's because they made the wrong lending decision, he says. So they have no right to be loading that risk (of one person's default) onto every customer with a less-than-20 percent deposit.
“No bank should have permission to recover losses from bad decisions by charging systematically from a whole section of customers.”
He says a couple earning good salaries but with not much deposit poses very little risk to a bank; nor does someone whose parents are guaranteeing their loan.
“I’d like to see how much money banks actually lose on low equity loans.”
Are low equity loans more risky?
We asked the Reserve Bank. The answer is that low equity loans are potentially more risky - if the housing market goes down. Research the RBNZ released in 2013, but sent to Newsroom in answer to our questions, studied the period after the 2007 global financial crisis. And our central bank found that in a property slump, low equity loans are definitely more risky than higher equity loans.
(Note that in the quote that follows, the Reserve Bank uses the term “high loan-to-value ratio” or high LVR loans, rather than “low equity" ones. They are basically talking about the same thing. And remember, the bank is talking about the period 2007-2013.)
“The data showed that loss rates on high-LVR loans generally increased more (in several cases substantially more) during the recent economic downturn than loss rates on lower LVR loans,” the Reserve Bank said in 2013. “This is consistent with losses on high-LVR loans being more highly correlated, and suggests that high-LVR loans have more systemic risk than lower LVR loans.”
The Reserve Bank’s post-GFC concerns led it to introduce LVR restrictions on banks in 2013, which in turn led to the introduction of LEPs by the banks.
If you are introducing differential pricing based on someone’s hair colour, you better show me what’s the rationale
Still, are the banks justified in using LEPs? Einarsson says not.
This is not a market with falling house prices, nor one where big falls are likely. And even though there is the potential for a downturn sometime in the future, Einarsson would argue the Reserve Bank’s concerns should simply prompt banks to be more careful about who they lend money to. It shouldn’t lead to a blanket punishment for everyone with a low equity loan.
“If you are introducing differential pricing based on someone’s hair colour, you better show me what’s the rationale to differentiate on the back of someone’s hair colour.”
The banks respond
So we asked the banks. Tell us about your LEPs. And we got some interesting feedback.
BNZ, Kiwibank and Westpac made similar statements.
BNZ told us: “Lending on low equity loans is riskier and we have a responsibility to make sure our customers can afford the repayments on their home loans. We take this very seriously.”
Westpac said it “is committed to helping New Zealanders achieve their home ownership goals, including buyers with a high loan-to-value ratio”.
And Kiwibank: “As a responsible lender we must ensure that customers are able to afford their borrowing. The differentiated price for customers with low equity is due to the greater capital requirement for the bank.”
These statements from the three banks seem somewhat difficult to understand. The banks are basically saying that to ensure their low equity customers can afford their repayments, they charge them a higher interest rate. It’s like they believe it's helpful for customers that they are paying thousands of dollars more than they otherwise would if there was no LEP.
Kiwibank's head of borrowing and saving, Chris Greig, says his bank needs to charge customers the 0.75 percent difference between the special rate and the standard rate because of the Reserve Bank's extra requirements around low equity lending. "We are not making additional profit on the standard interest rates, we are covering our cost of capital."
Remember Kiwibank no longer charges an LEP.
BNZ spokesman Sam Durbin also talked about the Reserve Bank restrictions.
"For owner-occupiers, RBNZ requires us to hold materially more capital for these loans than for someone who has an LVR of less than 80 percent. To reflect the increased cost of capital and risk, BNZ adds a low equity premium on the interest rate only."
Durbin says New Zealand banks aren't the only ones in the world to charge LEP-like margins. He mentions Australia's LMI (lender mortgage insurance), an up-front fee added to low equity mortgages and paid off over two years. He also says the UK uses a tiered interest rate system, although in this case, the loans are revalued every three months using both valuation and debt repayment figures.
Durbin says when a customer achieves an LVR below 80 percent, "we remove the LEP at the next available opportunity.
"Given the huge popularity of fixed term home loans in New Zealand, which locks a rate in for a period of time, that's generally when the fixed term ends and we're talking to customers about their options."
The most popular fixed term in New Zealand is two years, though fixing for up to five years is also offered by banks.
Durbin says the end of a fixed loan is also the main trigger point to revalue a property.
"If for example, a customer's property went down in value and they were suddenly above 80 percent LVR, we wouldn't look to put an LEP on that lending."
But what if the price goes up - as is much more likely in the present real estate climate?
Banks out on a limb
Einarsson says LEPs are a kind of shaming tactic.
“Banks love to put something in front of you and say, ‘Sorry, I’m going to have to charge you a bit more because you haven’t saved enough’.
“They are there to get as much out of people as they can.”
He understands banks' argument about the RBNZ costs, but says if banks insist on charging low equity premiums to cover off additional risk, they should hold the extra amount in a separate account. Then if the customer gets to 20 percent equity without a default, they should get their money back. A bit like a deposit on a rental property.
But better still, Einarsson tells the banks, just don’t charge extra to cover risk. Other industries don’t.
“If I go to a car yard to get a car and the person thinks I’m a bit dodgy, they aren’t going to charge me more. Tenants aren’t charged more rent because they are a higher risk.”
Financial author Mary Holm says we need better regulation of the banks.
“Banks aren’t voluntarily going to make changes, and low equity premiums aren’t the kind of things competition is going to change. A customer isn’t going to choose Bank A over Bank B because Bank A will be more proactive in looking at their current mortgage balance and doing regular revaluations of their house to make sure they are paying the right low equity premium.”
It’s just too complicated.
BNZ told Newsroom "right now we're looking at ways we can automate the process of removing the LEP to make this a smoother and easier experience for customers". ASB and Westpac said they had no plans to change their LEP practices.
So what are the regulators doing?
There are a couple of problems with getting the regulators to look at changes to the low equity premium regime.
First, unlike industries like electricity or telecommunications, New Zealand doesn’t have strong, specific regulations for the banking sector. Yet, anyway. And the task of checking on banks is split. The Reserve Bank, the Financial Markets Authority, the Commerce Commission and the Banking Ombudsman all have a part to play, depending on what issue is involved.
Second, low equity premiums don’t seem to be on the radar, either for consumers or for regulators. People don’t see what’s happening, so they don’t complain. Organisations that might otherwise be concerned, whether it be Consumer NZ, Fincap, the Banking Ombudsman or the Ministry of Business Innovation and Employment’s Consumer Protection division, aren't getting complaints, or not many, so they don't seem to have LEPs on their radar.
Banking Ombudsman Nicola Sladden says the organisation has received only four inquiries related to LEPs since July 2015. She says that's probably because the Reserve Bank's LVR restrictions have reduced low equity lending over the past few years.
"But more broadly, this issue raises the importance of the banking sector taking a greater role in the financial wellbeing of their customers, and that's the message that's coming out of the [Financial Markets Authority and Reserve Bank] conduct and culture reviews," Sladden says.
Ministry of Business, Innovation and Employment spokesman Matt Winthrop has a similar message: “Low equity premiums were not identified as a specific issue in the Government’s recent reviews of conduct of banks. However, the new conduct regime for financial institutions will require banks to consider whether all products and services, including fees and interest charges associated with those products and services, are consistent with a principle to treat consumers fairly.”
This legislation is expected to be introduced to Parliament by the end of the year, Winthrop says.
Rob Everett, chief executive of the Financial Markets Authority, which will be responsible under the new regime for making banks treat customers fairly, didn’t want to comment specifically on LEPs. But he has been outspoken for months about banks behaving badly. This includes openly criticising banks for their treatment of customers, including the way they have under-invested in systems that could protect customers and save them money.
Everett says the focus on bank conduct - or misconduct - needs to be consistent and relentless.
“If the focus on that behaviour and the treatment of customers is allowed to come off, bad things happen.”
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