Banks on the hook: Institutions struggle amid growing wave of underwater mortgages in China

A growing number of mortgages are falling underwater as China’s real estate crisis enters its fourth year and home values keep falling, putting further financial burden on both individuals and institutions.

These days, as job losses rise and income growth slows, many are debating whether it’s worthwhile to fight to make loan payments on properties with negative equity.

A finance worker in Shanghai has to pay off her past-due mortgage or risk legal action from her bank. In Hangzhou, one man is forced to sell two residences at a loss of one million yuan ($138,000) after his repayments spiralled out of control, and another couple has postponed having a child and is depending on their parents to help pay their home loan.

The possibility of negative equity is a worry for banks as well. Those with knowledge of the situation said that at least two lenders brought up the problem during a recent meeting with China’s financial authorities, who promised to look into it. They asked not to be named since the discussions were private.

After Lucy Liu missed four payments on a 3 million yuan mortgage for her Shanghai house, her bank is threatening to take her to court. This is a stark contrast to three years earlier, when she paid 4.2 million yuan for the property, believing that home values would only rise. Since then, she quit her high-paying career and took a position that paid 80% less, and the value of the property has dropped below what she owes.

The 32-year-old financial worker said that she has lost all hope, explaining she fears the price will continue to fall, leading to a bigger loss.

She added that if she stopped repaying the bank, she may only lose the down payment, but if she continued paying, she may lose more.

Proxy data indicates Liu is not alone in having trouble repaying her house loan, even if it is challenging to quantify the issue due to a dearth of current data on underwater mortgages and defaults. According to data published by Bloomberg, household debt reached a new record of 145% of disposable income per capita at the end of 2023. This is much higher than the percentages of 126% in the UK and 97% in the US.

The country’s banks are already battling diminished balance sheets as a result of an increase in bad loans and declining profit margins. Significant competitors Industrial & Commercial Bank of China Ltd. saw a 9.6% increase in bad loans from residential mortgages to 27.8 billion yuan, while Agricultural Bank of China Ltd. reported a 4.7% increase in soured residential mortgage loans last year. In March, Bank of Communications Co. reported that its property bad loan ratio for money lent to developers jumped to almost 5% at the end of last year from 2.8% a year earlier.

And the list of disappointing statistics keeps growing: According to Changjiang Securities Co. chief economist Wu Ge, the residential mortgage delinquency ratio jumped to the highest in four years as of late 2023; the number of foreclosed properties listed for legal auction hit a record in 2023, according to data from China Index Holdings; banks issued 24.7 billion yuan in financial instruments backed by non-performing mortgages in 2023, the most ever, according to cn-abs.com data compiled by Bloomberg.

Some homeowners on the verge of defaulting on their mortgages have had to delve into family funds and postpone life plans. Peter, who lost his job at a fintech business in Hangzhou last year, now relies on his parents to pay his mortgage. His wife remained employed, although with a significant salary decrease.

The 32-year-old said they planned to have a baby last year but gave up.

To be sure, banks may still collect at least a portion of the loans by selling the collateralized properties in the event of a default and enforcing on the borrowers’ other assets to recover loan losses.

However, if homeowners fail to make payments, they will be subjected to lawsuits by the bank, have their home repossessed, and finally be sold at a 20% to 30% discount. Because China lacks countrywide personal bankruptcy legislation, defaulters will be held liable for their arrears in most circumstances, resulting in a tarnished credit record that may have a long-term influence on their future financing eligibility.

Some people are attempting to avoid these repercussions, even if it means taking a significant financial cost and learning a hard lesson.

Carl, a former Hangzhou property consultant, had to sell two of his residences for a total loss of 1 million yuan to pay off his mortgages, one of which went underwater. After the sale, he still had to pay an additional 110,000 yuan on the property to settle the loan. At one point in 2022, he had a monthly mortgage expense of over 30,000 yuan, nearly double his salary, prompting him to take out consumer loans to pay off the debt.

China’s recent attempt to breath life into the property market by trimming downpayment requirements is also being questioned.

“Reducing the downpayment ratio is treading a tightrope,” said Raymond Yeung, Greater China chief economist at Australia & New Zealand Banking Group Ltd. “If the action fails to revive demand, lowering the downpayment ratio will increase the risk of falling into negative equity. New buyers taking 15% downpayment mortgage will have less buffer against price fall.”

According to Yeung, new homeowners took out 528 billion yuan in mortgages last year on properties valued 791 billion yuan, or 150% of total outstanding loans.

Yeung estimated that the markup among mortgage borrowers has been the lowest in the previous 12 years, implying that a 33% decrease in property prices might put them into negative equity.

According to Bloomberg calculations based on government statistics, China’s new home prices have fallen 5.7% from their peak in 2021, while existing home prices have plummeted 11.4%. According to a report issued this week, Jefferies Financial Group Inc. predicts housing values in major cities will fall by at least another 30% before stabilising.

However, some homeowners are attempting to persevere — for the time being. Chenchen, who works for a private property business in Shanghai, has little alternative but to continue paying her mortgage so that her child may attend a local school. The 38-year-old hasn’t been paid in five months, and her home’s value has dropped by 40% to 4.5 million yuan.

Joan, a Shanghai property agent, stated that if she continues to repay her mortgage, her money will last no more than two years. She hasn’t been able to sell any residences since April and doesn’t expect the property market to improve until 2027, which means no steady income for the next two years.