Monday, June 29, 2015

Rising Prices Aren't Always Good For Home Owners

Contrary to popular belief that all home owners benefit from rising prices, that is not always the case.

Younger generations who are yet to buy a long term home, who may have purchased a smaller property that suits them for the short term or just to get themselves onto the “property ladder”, may be disadvantaged if they intend to upgrade in the future.

Take the case of a Sydney family who bought a $400k 2 bedroom apartment to tide them over for a few years. They had a 75% LVR to begin with, putting in a 25% deposit, but lower interest rates have assisted them in paying down the principal aggressively and as it stands have an LVR of 60% on purchase price ($240k mortgage). They’ve outgrown the apartment with a new addition to the family and want to now purchase a 3 bedroom house. Let’s look at three scenarios in which they sell their apartment and buy back into the same market.

Original value of 2 bedroom apartment: $400k
Original value of 3 bedroom house: $550k
Sale fee (real estate agency to sell apartment): 1.5%
Stamp duty (to buy house): Calculated on NSW rates

Scenario 1: No Price Change. ($400k apartment, $550k house)
Stamp duty: $20,500
Sale fee: $6000
Cash left for new purchase: $133,500
That’s a 24% deposit leaving a $416,500 mortgage on the new home.

Scenario 2: Prices Rise by 10%. ($440k apartment, $605k house)
Stamp duty: $23,000
Sale fee: $6600
Cash left for new purchase: $170,400
That’s a 28% deposit leaving a $434,600 mortgage on the new home.

Scenario 3: Prices Fall by 10%. ($360k apartment, $495k house)
Stamp duty: $18,000
Sale fee: $5400
Cash left for new purchase: $96,600
That’s a 19.5% deposit leaving a $398,400 mortgage on the new home.

So in the three scenarios above, while the steady or rising prices result in a larger deposit for the new home, allowing a lower LVR, it also sticks the owner with a larger mortgage.

Which of the above 3 mortgages would you prefer to have for the same 3 bedroom house (all else being equal)?

Of course not every situation is the same, a larger fall than 10% may result in Lenders Mortgage Insurance being payable or result in the apartment owner being underwater (mortgage exceeds value of home or is high enough that selling won't leave a large enough deposit) and locked into their unsuitable abode.

The point of this short post was just to highlight the furphy that many spread to suggest that all homeowners benefit from rising prices, when the reality is that it often just means a larger mortgage when they upgrade to their next home.


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Tuesday, June 9, 2015

Adam Carr Wrong on Australia's Housing Affordability

Adam Carr had this to say on housing affordability in Australia (via Business Spectator)...
"...housing is still actually very affordable."
Carr was prepared to dive head first into showing how an $800,000 property is affordable on a $100,000 salary.
"A household on $150,000 could afford a $1 million-plus house -- no dramas. Someone on $100,000 could afford anything in the vicinity of $650,000 to $800,000. A lot depends on the loan-to-value ratio they’re taking -- I’ve used 70 per cent -- but it can be done."
Ok, let's break this down. $100,000 would be roughly $73,000 net, $1403/week. Carr is working from a position that they've saved a 30% (+ costs) deposit. Using $32,000 for stamp duty and fees (I went with NSW figures) and ignoring any other transaction costs (such as legals)... that's $272,000 required in savings (the deposit) before we can even start checking the affordability of the remaining mortgage. Based on a savings rate of 30% of net income ($21,900 per year, very generous if you ask me), it has potentially taken this buyer more than 12 years to save the deposit that Carr says they have on hand. That should already be raising alarm bells on this so called "very affordable" property market we have.

Now we could make any number of assumptions about this buyer, maybe he/she had property that appreciated in value before buying this one, maybe they have bank of mum and dad chipping in, maybe they're a gun investor who has turned a little savings into a lot of capital to fund the deposit... but these would be unfair presumptions to make. We could scale back the price and incomes at a comparable ratio and it would still look awful... e.g. someone on $50,000 buying a $400,000 property (for their first home) and using a $135,000 deposit will have to save for 10+ years using the same measure.

The mortgage repayments (on the remaining $560,000 loan) work out to $655 weekly (at 4.5% interest over 30 years). That's over 46% of net pay (34% of gross) and doesn't take into consideration the extra costs of ownership such as council rates, maintenance, insurance and more. It also doesn't take into consideration the possibility of interest rates rising, if they normalised to 7% the repayments would rise to $860 per week (61% of net income, 44% of gross).

Call me mad, but I don't consider Carr's examples to show affordable property any way you cut it (at least not in the way I think the word should be used)...

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