The real reason house prices are so high

Who’s to blame for the rise in house prices in Auckland and across New Zealand? I’m sure you are already making a mental list of the culprits. But here’s one that may not come immediately to mind – High Street Banks.

To understand how the buck stops with the banks you have to go back a few decades – because nothing happens overnight. It is not as if houses were affordable yesterday and not today.

But to cut to the chase, because we don’t have all day, the issue is the “loan-to-income ratio”.

When I was a lad the bank would lend me no more than 3 times my annual income. It meant that I was restricted on what I could pay for a home. And that “loan-to-income ratio” restriction applied to anyone wanting a home loan.

It kept house prices in check. Even if a foreign buyer came in to bid, while they may be able to bid above what I could afford with their cash, the bidding would stop at just above 3 times the annual income of the best paid person at the auction.

In the UK, for example, the “loan-to-income ratio” was 3 in the 1980s/90s, today it is 4.5. The “loan-to-income ratio” rule doesn’t appear to be in force in New Zealand. Let’s look at the math.

Let’s assume the annual average wage in New Zealand is $60,000, and let’s assume we have a couple combining their incomes. That’s $120,000, and we’ll times it by 4.5. That would give our couple a maximum mortgage of $540,000. Apply a more conservative multiple of 3 and it’s $360,000.

Had the banks not lent people more than 4.5 their annual (before tax) income then the price of houses would be affordable today.

All the time banks lend people 5, 6, 7 and more, times their annual income so house prices will continue to bubble up.

The cause of unaffordable house prices, and house price inflation in places such as Auckland, is not the interest rates, it’s not that there are not enough homes – although that is clearly an issue – and it is not the government, nor the Reserve Bank… No. The issue lies squarely with commercial banks who know they can’t lose when they lend money on a house.

They know the prices will keep going up and should they need to foreclose they will be on a very good bet to get their funny money back.