Email Newsletter - August 2007

Federal Inquiry into Mortgage Finance

In July it was announced that there would be a federal inquiry into mortgage finance due to the large increase in personal bankruptcies and the high default rate on mortgages.

Bruce Baird is chairing the committee and, among other things, will look at the extent of the problem, the role of mortgage brokers and whether fierce competition between banks is eroding prudent lending practices.

One of the big concerns seems to be that borrowers are able to borrow 100% of the purchase price of a property and home buyers are not building up and savings before going and buying a property.

But is it all the fault of the lenders…..

First Home Owners Grant

Personally I’m not a big fan of 100% Home Loans, but they do exist and we have lenders on our panel that lend 100% or more of the purchase price of the property.

However, even if you borrow 100% you still need to save to cover the cost of Stamp Duty……except now the government has given first home buyers an exemption from Stamp Duty. And just in case there are any other expenses like solicitors fees, the government also hands out $7,000 to really make sure that you don’t need any savings to buy your new home.

And then they wonder why people are buying houses with no savings!

Do I really need savings before I go and buy a property?

The reality is that you don’t need savings because lenders offer 100% home loan. However, I would suggest that you get used to saving if you are serious about buying a house.

The figures vary from state to state, but in Sydney rental returns are about 4%, and home loan interest rates are around 7.5%. So broadly speaking, if you are paying around $265 per week in rent, your mortgage payment would be at least $500 per week for a similar property (assuming you borrowed 100% of the purchase price).

We speak to people all the time who tell us they have done their sums and can afford the $500 per week in mortgage payments. However, logic suggests that if you can afford $500 per week and are currently paying $265 per week, then you should be able to put $235 per week into a savings account. Unfortunately, many people don’t comprehend this before they rush out and get a mortgage.

I’m not suggesting you save a 20% deposit. But I would at least suggest that you try saving for a few months to prove that you can afford the mortgage payments.

How Much Can I Borrow?

Lenders have different ways of calculating how much you can borrow. Lets say for example that we work out that based on your income you can borrow $300,000. There are clients who will tell us that it’s not enough and they can really afford $400,000…and there are clients who tell that that is way too high and they can only afford $200,000.

And guess what? They can both be right.

I’ve seen high-income earners struggle with relatively small loans, and unfortunately there is no easy way of telling who is going to struggle until you see some history.

So what is the Answer?

OK, the First Home Owners Grant is good for my business because it means more people buy houses. But more demand for houses also pushes the prices up. Combine that with 100% home loans and you have higher monthly repayments and the ability to get a loan with very little savings.

Personally, I think there are probably better ways of helping borrowers with long-term tax breaks rather than loading them up with cash and helping them buy a house with no savings.

Interest Rates

We had news this week that Interest rates have gone up again. This is the latest in a string of rises over the past few years. The media has been all over the story so I won’t go into details about how much of a burden this is to the average homebuyer. I just wanted to include some general information for your education.

1. The Blue line shows the official Reserve Bank rate for the past 10 years. This latest rise takes us above the small peak we had in 2000 and puts us at the highest level in 10 years.

2. Where rates go now is anyone’s guess. In 2000 they reached a similar level and turned back again. They could just as easily keep rising from here.

3. Anyone who took out a loan since 2001 would have been brave to predict that rates would continue to fall.

4. The pink line in the chart is the bank’s “Standard Variable” rate. Back in the mid 1990’s, the bank’s margin (the difference between the blue and pink line) was greater than it is now. The other thing that’s changed is that more people are getting discounts off the Standard Variable rate. In the 1990’s less than 50% of borrowers got a discount. These days over 96% of people get a discount from the Standard Variable rate. Mortgage Brokers have contributed to this because we can help you compare all lenders rates in one go. The Internet has also given borrowers access to more information.

And for anyone sitting there thinking “I wonder what happened to interest rates over the past 50 years”, here it is:

Struggling Borrowers or Media Beat-up

The newspapers have been full of stories about families struggling with mortgage payments following the recent rate rises. On Saturday the Telegraph ran a “Special Report” on the front page detailing the plight of one family in Sydney’s Condell Park. So lets have a closer look at the details and you can make you own decision on where the fault lies:

The basic details are:

• The family spent $750,000 on the property since 2004.

• Interest rate increases mean they now spend $1600 per week on mortgage repayments and have no option but to sell

• They have reduced the price to $500,000 but still have no interest in the property.

So now lets read between in lines of this “in depth report”:

• The wording the article indicates that they probably built the house rather than purchased. Unfortunately, it's very easy to get carried away when building your "dream home" and end up spending more than you budgeted for.

• According to RP Data, the median price for a property in Condell Park is $420,000. This makes $750,000 seem like a lot to spend.  A quick search of www.realestate.com.au shows that $600,000 is right at the top end for the area.  And for $750,000 you can get an absolute palace.

• The purchase price, or building cost, of a property has very little to do with the value of the property. The value of a property is what people are willing to pay for the property.

• They quote the repayments as $1600 per week. This seems like an extremely high repayment. Given that he is self-employed as a courier, and the property was purchased in 2004, I would guess that he is on one of the old Low Doc loans. Rates for low doc loans have reduced greatly in the past few years. The problem is that he would have difficulty refinancing if the property is valued at less than what he owes the bank. The article doesn’t say how much he owes but given the repayment quoted I’m guessing it’s right up there.

• Looking at the history of interest rates in the charts on this page, anyone buying a house around 2004 would be fooling themselves if they thought rates were going to stay that low.

• And finally, the article says that the husband will have to stop working his courier business because he needs to take six months off for a knee reconstruction. I’m guessing that the governor of the Reserve Bank hasn’t been out there with a crowbar and whacked him across the kneecap. I would suggest that even borrowers with a modest $300,000 mortgage would struggle if they had to take six months off work.

• And it doesn’t say if he had any income protection insurance to cover himself while he is out of work (probably can’t afford it with a mortgage that big).

So while I can sympathize with borrowers who see their repayments increase every month, we all need to exercise a bit of common sense when taking out a mortgage:

• Don’t borrow too much and over-extend yourself.  It's important to live within our means

• Allow for rate rises

• Don’t over capitalize your property

• Make sure you have income protection insurance and life insurance to cover yourself in case of hardship.

• Build your dream home when you can afford your dream home. 

Next Month

A few weeks ago the majority of you had probable never heard of the sub-prime market.  Next month we will find out what it's all about and how it might affect you.