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.

Inputs:
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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