First Home Quicksand
I recently read an article online stating that Perth’s median house price is forecast to hit $600,000 by the end of 2014. What first staggered me about this statistic is the dramatic divergence between median income and the median house price. The latest RBA published statistic on median income was $57 400 per person. The house price to income ratio is a proportion of the median house price to median income in a given geographical area. In Perth the ratio is more than a factor of 10 times, the global average is closer to 3 times. I was reading a publication that justified this huge variance stating that ‘a key factor in the jump in the house price to income ratio over recent decades has been the structural reduction in interest rates. Mortgage interest rates in Australia in the 1980s averaged around 14 per cent, but since 2000 the average has been closer to 7 per cent”. The cost of borrowing has never been cheaper with standard variable rates ~ 5% and the RBA cash rate at 2.5%. These are all time historical lows and only have one way to go. The contrarian investor within me is tempted to whisper ‘Bubble’ however given I’m not an economist I’ll stop speculating and rather direct my comments to something I do know. That being how incredibly difficult it is for first home buyers to enter the market. My younger cousin has recently dipped her toe into the water and has been forced to buy a house just short of the end of the yellow brick road to find something she could afford. The commute is killing her apparently. More troubling in my opinion is that first home buyers may have a storm brewing: House’s on a relative basis are incredibly expensive, interest rates are at all time lows and many first home buyers are Generation Y’s with an inherent ‘I want it now’ attitude. The potential result is high levels of unsustainable debt. The critical point for first home buyers (and everyone for that matter) is not to over extend yourselves by taking on too much debt. Don’t start shopping on the basis of maximum borrowing potential. For many first home buyers there is a raft of expenses on the horizon, land rates, kids, and school fees. The last thing you need is to be losing sleep at night over your finances. Before making the biggest financial decision of your life and buying your first home please consider the impact of interest rates rising materially from current levels, it may not happen in the next year, but it will happen at some point over the term of a 30 year loan. Rates (like my loyalty to the West Coast Eagles) are cyclical: Please consider the below scenarios:
The impact on personal cash flow from interest rate increases Current variable home loan rate is ~ 5% The average Standard home loan rate from 1990 – 2012 was 8.44%. If standard home loan rates return to a 22 year average, interest repayments on a $500,000 home will increase by $263 a week ($13,676 per annum) in after tax dollars a year.
The positive impact of making extra repayments Instead of borrowing as much as possible a couple purchases a home for $400,000, well within their ability to make additional repayments. Because they were more conservative they have a monthly repayment that is $537 lower then scenario A’s couple. They then choose to continue to make the repayments as if they had borrowed the full $500,000 and contribute that extra $537 a month off their $400,000 loan. If a couple who had the lending capacity to purchase a $500,000 home instead purchased a home for $400,000 and directed the difference in payments toward their mortgage, they would own their home 10 years earlier and pay a total of $229,754 less to the Bank in interest.
Make sure you dip a stick into the sand to test the depth before you step in.
Written by Trent Doust of Sage Financial Group House’s on a relative basis are incredibly expensive Financial House’s on a relative basis are incredibly expensive Financial Planner First Home Quicksand financial planner home will increase