A cautionary tale

 

To my surprise, a “vintage” three-bedroom timber house in need of significant work, or more likely demolition and rebuild, had just been sold for $980,000. Now, just remember, this is Queensland, and not Sydney or Melbourne.

Anyway, it got me thinking.

House prices have been going through the roof in many parts of Australia over the past year or so. And many houses that hit the market don’t seem to be around for very long before they are snapped up by eager buyers

So, where does the money come from to pay for a new home?

In most cases, borrowed money is needed to complete the purchase.

According to a June 2021 article published by 7news.com.au , the average Australian mortgage in April 2021 was just over $560,000. The average mortgage in Sydney or Melbourne is likely to be significantly more. These are “eye-watering” numbers.

On the other hand, interest rates are at levels we have never seen before. The average variable home mortgage rate as published by Finder.com.au, is 3.93% and the lowest rate they have on their site is 1.85% .

While interest rates remain at their present level, new homeowners should be able to continue to service their home loans, particularly if they have prepared a realistic budget before committing.

But what happens if interest rates start to rise – as they surely will?

According to the government’s MoneySmart website the principal and interest repayments for a $560,000, 30-year mortgage with an interest rate of 2% per annum, will be $2,070 per month, or $24,840 for a year. Repayments made over the 30-year period of the loan will amount to $745,153 – and that assumes there is no increase in interest rates for the next 30 years!

But what if interest rates increase to 4%?

The monthly repayments for that same 30-year loan will jump to $2,674 per month ($32,088 for a full year). And the total amount repaid will increase to $962,469.

And what would happen if interest rates increased to 6%?

By now you may think that I am being total unrealistic suggesting interest rates would ever go so high. But that is exactly where interest rates were back in 2014.

The same loan, with an interest rate of 6% would require monthly payments of $3,357 per month or $40,284 for the year. Total repayments would amount to a massive $1,208,684.

Interest rates are at an all-time low and it will be very tempting for aspiring homeowners to cut their budget to the bone just to get into the housing market. That is perfectly understandable.

If you currently enjoy the very low home mortgage interest rate environment, or if you are planning to start climbing the property ladder, here are a couple of tips before committing:

  1. Be very realistic with your budget – don’t overlook or under budget anything – it may come back to haunt you.
  2. Factor in an increase in interest rates into your budget even before you start – instead of budgeting for an interest rate of (say) 2%, look at how an interest rate of 3%, 4% or even more, would impact on your ability to service your mortgage.
  3.  Even better still, even if your current interest rate is (say) 2%, make repayments based on an interest rate of 4%, or even higher. Not only will you get ahead of your repayments and save interest in the longer term, but you will also build a buffer against unforeseen circumstances that might arise in the future like an illness or injury, job loss, or having to take time off work to care for family.

Having a mortgage safety net will also benefit your mental health enormously. You will keep your head when everyone around you is losing theirs!

Purchasing a home for the very first time, refinancing an existing home, or upgrading to better home can be an exciting time. However, taking a few simple steps will help to make the journey even more enjoyable.

Did you know – back in 1989 home mortgage rates in Australian topped 17%. To put this into context, the same 30-year $560,000 mortgage we mentioned above would have required repayments of $7,984 per month and the total amount repaid, had interest rates remained at that level, would have been $2,874,161!

Sometimes the “good old days” weren’t all that good.

Sources:
1. Housing lending goes through the roof | 7NEWS
2. Australian interest rates 2021: current mortgage rates | Finder
3. Mortgage calculator – Moneysmart.gov.au

Footnote:
Mark and I have been publishing our weekly blogs for almost eight years. Hundreds of articles and hundreds of thousands of words have flowed from our keyboards. We are not writers or journalists but rather, we are a couple of “techo’s” that provide technical advice to financial advisers.

We enjoy writing these articles each week and sincerely hope that our readers find some useful information on these pages.

Moving forward, and to help us manage our respective workloads more effectively, the Realise Your Dream weekly blog will be moving to a fortnightly publication.

We encourage you to continue the journey with us and, as always, if you have any topics you would like us to cover in future posts, please feel free to leave a comment in the response box.

Tealey and PK

 

Peter-Mark

ABOUT US

Peter Kelly

PK believes people have the right to accurate, affordable and unbiased information that addresses all aspects of their preferred retirement lifestyle, thereby giving them the opportunity to make informed decisions that will empower them to live out their lives with dignity, certainty and security.

 

Mark Teale

Tealey’s ambition is to change how people think about their retirement, he wants people to dream, plan and realise retirement is not defined by a magical age prescribed by the legislation.

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