A Guide for Hong Kong Negative Equity and Call Loans

The volatility of the Hong Kong real estate market has made negative equity a significant concern. The financial strain caused by negative equity on property owners is substantial, with far-reaching implications for the market. This article delves into what negative equity is, its causes and impacts, and offers practical advice on handling call loans to help property owners better navigate market fluctuations.

What is Negative Equity?

Negative equity, simply put, occurs when the value of an asset is less than the outstanding loan amount. For property owners in Hong Kong, negative equity arises when the market value of a property falls below the outstanding mortgage loan. This means that even if the property is sold, the proceeds would not be enough to repay the entire loan, placing the owner in financial difficulty.

Hong Kong Negative Equity Hits 20-Year High in 2024

In the first quarter of 2024, the number of negative equity cases in Hong Kong reached 32,073, marking a 20-year high. Compared to the previous quarter, the number of cases increased by 27.5%, with the total loan amount involved rising by 25.9% to HKD 165.3 billion. These figures indicate that the issue of negative equity in Hong Kong is worsening, posing increasing risks to property owners and financial institutions.

Types of Negative Equity

Negative equity is not limited to residential properties but also includes commercial properties and other assets.

1. Residential Property Negative Equity: This is the most common form of negative equity, occurring when property values fall below the loan amount, making it difficult for owners to repay their mortgages.
2. Commercial Property Negative Equity: Commercial real estate values can fluctuate significantly. When market demand decreases or economic conditions deteriorate, commercial properties are prone to negative equity.
3. Other Asset Negative Equity: Investments in business equipment or vehicles, for example, can also experience negative equity if their market value drops below the loan amount.

How to Calculate Negative Equity?

Formula: Negative Equity = Property Market Value - Outstanding Mortgage Loan

Steps:

1. Estimate Property Market Value: This can be done through a market comparison or by directly querying the bank for an appraisal.
2. Check Outstanding Loan Amount: Property owners can find this information in their loan agreements or bank statements.
3. Calculate Negative Equity: Subtract the outstanding loan amount from the property’s market value to determine the negative equity.

For example, if a property is valued at HKD 4 million, but the owner still owes the bank HKD 4.5 million, the negative equity would be HKD 0.5 million (4 million - 4.5 million = -0.5 million).

Why Does Negative Equity Occur?

Rapid Property Price Corrections

The adjustments in the Hong Kong property market and economic fluctuations are primary causes of negative equity. Notably, changes in government policies and deteriorating economic conditions can lead to significant drops in property prices, causing the value of properties to fall below their loan amounts. For instance, the 2019 Policy Address eased mortgage insurance requirements, increasing the borrowing ratio. Many property owners, having made small down payments, are at risk of falling into negative equity when property prices drop.

High Leverage Borrowing

High loan-to-value (LTV) mortgages pose significant risks as borrowers who make minimal down payments can secure large loans. Even slight market fluctuations can drastically reduce property valuations, pushing owners into negative equity. According to data from the Hong Kong Monetary Authority, higher LTV ratios directly correlate with an increase in negative equity cases. Property owners with high LTV mortgages are susceptible to negative equity even with modest declines in property prices.

What is a Call Loan?

A Call Loan, or Callable Loan, is a type of short-term loan that can be called in for repayment at any time. It is typically interest-based and provides flexibility for borrowers to access funds as needed. Conversely, banks or financial institutions can require early repayment to mitigate their risk, usually when the property’s value drops below the loan amount.

Advantages and Disadvantages of Call Loans

Call Loan Mortgage Application Process

1. Identify Needs: Determine the required loan amount and its intended use.
2. Choose a Lender: Select a suitable lending institution based on terms and conditions.
3. Submit Application: Complete the application form and submit the necessary documents.
4. Negotiate Terms: Discuss and agree on loan terms with the lender.
5. Approval and Disbursement: Upon approval, sign the agreement, and receive the funds.

Important Considerations for Call Loan Mortgage

1. Credit Rating Review: Lenders assess borrowers' credit ratings to determine loan terms. Maintaining a good credit record helps secure better terms.
2. Monitor Interest Rates: Call Loan interest rates can fluctuate with the market. Borrowers should monitor market trends to choose optimal repayment times.

When Will Banks Call Loans?

1. Significant Drop in Property Value: If the property value falls below the loan amount, banks may call for early repayment to reduce risk. This ensures that the loan is not jeopardized by the decline in property value.
2. Borrower Default: If the borrower fails to make timely repayments or commits other defaults, the bank may initiate a Call Loan to prevent further risk exposure.

Hong Kong Call Loans: In Hong Kong, Call Loans are relatively rare due to the active property market. Properties are easily resold, and banks typically avoid demanding early repayment to minimize management costs and risks.

Will Banks Immediately Call Loans and Foreclose on Negative Equity Properties?

As the lienholder, banks have the right to call in loans at any time and decide whether to repossess the property based on specific circumstances. The Call Loan amount can be determined by the difference between the latest property appraisal and the original loan. In some cases, banks may require repayment of the entire loan. If the owner cannot pay, the bank has the right to repossess the property and auction it off. These properties are commonly referred to as “Foreclosed properties.”

However, due to market fluctuations, banks typically do not immediately repossess properties just because they fall into negative equity. The main reason is that the process of calling loans, repossessing, and auctioning properties requires significant time and administrative costs. If the owner cannot repay the loan, these amounts can easily become bad debts, increasing the bank's loss risk. Additionally, when banks approve high LTV mortgages, over 60% of the loan amount is usually guaranteed by mortgage insurance, reducing the bank's lending risk. Therefore, even if the property falls into negative equity, banks do not usually take immediate action. As long as the owner continues to make timely repayments, banks typically do not demand immediate loan repayment.

How to Avoid Negative Equity Leading to a Call Loan?

To avoid the risk of a Call Loan due to negative equity, it is crucial to avoid “high leverage borrowing.” In Hong Kong, first-time homebuyers can borrow up to 90% of the property value through government mortgage insurance or up to 95% through developer-offered high LTV mortgages. However, such high leverage means that if property prices drop by 5% to 20%, the property can quickly fall into negative equity. Therefore, to avoid negative equity and the risk of a Call Loan, property owners and prospective buyers should consider the following investment strategies:

1. Reduce High Leverage Borrowing: Lower the borrowing ratio and opt for lower LTV mortgages to reduce the risk of negative equity, maintaining greater financial flexibility during market fluctuations.
2. Plan for Sufficient Down Payment: Ensure an adequate down payment to avoid over-reliance on loans. This enables property owners to absorb losses in the event of a property price decline, avoiding negative equity.
3. Establish Emergency Funds: Building a reserve fund is crucial for coping with market volatility. Property owners should cultivate a habit of regular savings to create sufficient emergency funds to deal with potential financial difficulties.
4. Investment Strategy Suggestions: Consider diversifying investments by spreading funds across different asset categories to minimize risk. This approach reduces dependency on a single asset during market fluctuations.

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Although the risk of negative equity and Call Loans is relatively uncommon in Hong Kong, their impact on property owners and the market is significant. Understanding the causes and impacts, and taking preventive measures, is key to reducing risk. Property owners should carefully assess their financial situation, choose appropriate borrowing ratios, and maintain good debt repayment discipline to cope with market fluctuations.

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