Ask Susan: What happened when the government gave cheap home loans?

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A reader last week asked whether it would be possible for the government to offer home loans to first-home buyers at a set, fixed rate of 2 percent. I laid out some reasons why it probably wouldn’t work in the current environment – but some readers then wanted to know why it had worked until about the 1970s, when the government offered low-interest loans to first-home buyers, fixed for 30 years, via the State Advances Corporation.

Gareth Kiernan, whom I spoke to for the column last week, said even with that scheme, there were some conditions.

“It appears that the 3 percent interest rate was reviewed five-yearly, and if your income had gone above the allowable threshold, the interest rate was increased to the ‘normal’ rate. So fixed for 30 years seems to be simplifying the arrangement somewhat.”

He said it was a very different lending environment to today’s deregulated one.

“My colleague has told me stories, even in the early 1980s, of your ability to get a mortgage depending on how well you knew the particular bank manager, heavy restrictions on how much you could borrow, and often a need to take out second or third mortgages at exorbitant interest rates to get into your first home.”

David Cunningham, chief executive at Squirrel and former chief executive of The Co-operative Bank, agreed.

“The banking system was very different back then, and home lending wasn’t a priority in the way it is today. The Post Office Savings Bank was an important part of the landscape, with home ownership accounts a pathway into home ownership.

“In short, lending was constrained. The deregulation of the financial system in the 80s freed up access to credit, filling the role the State Advances Corporation had previously had. Higher inflation lifted interest rates as well.”

Kiernan said there was strong demand for the SAC loans – as you would expect – helped by people’s ability to capitalise their family benefit to be used as a deposit.

“At some points in time, the SAC loans were limited to the building of new homes or purchase of previously unoccupied homes to encourage an increase in the supply of homes and reduce the undersupply of housing.”

He said the government was still lending to first-home buyers at a lower rate than it was able to borrow at through the 1960s and 1970s, as it would if it were to run the scheme again today.

But he said some things were much different.

“There is greater competition for government funds than there was 60 years ago. In the 1960s, government expenditure averaged 23.5 percent of GDP, compared to 30.4 percent over the last decade.”

He said the financial sector was now operating completely differently.

“Access to lending is arguably much more open and equitable, so there is perhaps less need for the government to play a role in this space.

“Of course, the government still effectively underwrites some lending via the First Home Loan scheme, which is generally aimed at lower-income people with a small deposit looking to buy their first home.”

He said there was also more co-operation between central and local government and developers to create new subdivisions and developments in the 1950s to 1970s.

“The supply of land seems to have been much better … put it this way, a $1500 section in March 1959 prices would be equivalent to only about $42,600 now. That amount of money probably wouldn’t even cover some development levies now.

“My ultimate problem with the suggestion is still the question: what other government services/spending are you going to cut to enable this policy to take place? I’m not sure that people suggesting it understand that the pool of money isn’t bottomless.”

In the battle to bring inflation under control, would there not have been some merit in raising compulsory KiwiSaver contributions across the board instead of raising interest rates, thereby achieving a similar end result of reducing the spending capacity of the populace but with the advantage that that “lost” money would’ve been retained and ultimately have contributed to individuals’ long term retirement wealth? Arguably it would also have been a more palatable pill to swallow?

This is an idea that has come up a few times in recent years. Trevor Mallard actually raised it as he was leaving Parliament.

It is definitely an idea that has merit – I know a lot of people would feel much better about being forced to put more money into KiwiSaver, where it would benefit them in their retirement, than making higher mortgage repayments to the bank.

But there are some problems with the idea, too. One of the main ones would probably be that it would only be employees who were affected – unless you also required employers to increase their contributions, too.

It would also probably require making the scheme compulsory, otherwise people might just opt out to avoid the squeeze.

Another problem is that it might unduly affect those on the lowest incomes. Those who don’t own a home aren’t as directly affected by interest rate increases. But if they were compulsorily in KiwiSaver and the required contributions went up, they might not have a way to avoid that.

The money would also still be in the system, and fund managers would be looking for ways to invest it, which could mean some inflation pressure.

In short, this is an idea that feels great to a lot of people but there would be some issues to work through before it was practical.

Note: advice is generic in nature. Specific guidance should be sought from professional advisers.

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