“Oh please! Please, at least take a look!”
“No! We can’t afford it, move on.”
“Come on! We can – it’s not that much, we can do it!”
“How much is it again?”
“Listed for $1.3m, but think about the space for the kids and it’ll be a place to call home.”
“Hmm… what’s the address again?”
So went the conversation I overheard at lunch today between a young professional couple.
You could see it in their eyes really.
Hers was fixated and pleading, stubbornly refusing to let go.
His was unsure and trapped, not wanting to disappoint yet knowing deep down the truth… fear.
They were of course, referring to purchasing a property.
I still don’t quite understand why us Aussies have such a fixation with buying our own home.
In many parts of the world – it is perfectly acceptable to be life renters, yet here in Oz – the great Australian dream has always been to own a place your own.
It’s been passed down through the generations and I’ll wager will continue to.
It’s also a cause for many a heated discussion.
I didn’t mean to overhear their conversation though – just wanted to enjoy my Hainan Chicken Rice with vegetable spring rolls and ice lemon tea in peace okay.
But as soon as she opened her mouth – my ears were automatically drawn.
You see, I reckon this is a conversation many people have with their family, friends and associates.
Here’s a property. It’s perfect. I can imagine the kids room here, the rumpus room there. Let’s buy it.
If only life was so simpaul…
You see, there are a fair few considerations you must consider before purchasing your “dream” home.
Here are the main ones.
Can you afford it?
Self-explanatory with this one, never buy something which you cannot afford. Basic finance 101 people!
But, you’d be surprised how many of us don’t actually work this out BEFORE we make a purchase.
Let’s take our couple for instance, through a basic example.
If the property is listed for $1.3m – they are expected to fork up usually 10-20% as a deposit amount (most likely 20% to avoid lender’s mortgage insurance). Provided they put down 20%, they borrow the remaining 80% which is $1.04m.
For argument’s sake let’s assume they borrow $1m flat.
Comparison websites have home loans starting at high 3’s to low 4’s with lenders, so let’s assume they can borrow at 4% from a major bank for a standard 30 year mortgage.
So their monthly repayments would be $4774 for principle + interest or $3334 for interest-only (any bank calculator can give you the repayment amount).
Now, I don’t know their income levels, but for simplicity let’s assume they earn $100k p.a. each.
So net income per month is $6,110 each * 2 = $12,220 (a fair amount of dough).
But if they are forking $4774 per month – that’s about 40% of their income GONEEEEE. At $3334 – that’s almost 30%.
A common financial benchmark is for repayments (mortgage or rent) to not be more than 30% of your net income.
This example would put our couple in mortgage stress territory (or very much close to it).
Loan repayments P+I vs IO.
Here’s where they need to determine whether to repay principle + interest (P+I) or interest-only (IO).
As the name suggests, P+I is where you’re paying down the principle. Initially the repayments are mostly interest portions and a small amount of principle, but towards the end, most of the repayments go towards repaying the principle.
With interest-only, you are always just repaying back the interest, never the principle amount (a strategy used if the projected asset growth will be higher than the interest to be repaid).
For our couple, I’m assuming they are going to be living in the property – in which case they will most likely not be able to claim any tax deductions associated with it (tax deductions claimed against investment purposes).
If this is true – then unless they are repaying the principle + interest every month, the mortgage outstanding will remain there… like a sword… hanging… just… hanging…
Change in salary/family circumstances.
A young couple walks into a mortgage lender’s office.
The mortgage lender calculates their combined income and gives them their maximum borrowing capacity.
The young couple walk out and immediately begins to procure a shortlist of suitable properties close to the maximum.
They find their dream property, exchange contracts, obtain a mortgage and settle on their dream home!
Two years later, the wife gives birth to their first child and stays at home to “look after the kid”.
The husband begins to feel the burden of a single income repaying the same amount.
He is stressed.
Two years after, the wife gives birth to another child, and remains at home to “look after the kids”.
The husband, straining under the existing financial weight, cannot handle it…
Okay okay, it’s usually not as morbid as that – but I just wanted to state how important it is to think a few year’s ahead. It’s not unfeasible to think that once a couple start a family, one partner drops out of the workforce to raise the children.
Usually, that leaves one breadwinner for a few years at least to handle the repayments (Hans) solo.
In my mind, the most important and least recognized of the risks facing home-buyers in the market today is the (lack of) awareness regarding interest rates.
If you look around you, home loan interest rates are hovering in the high 3’s and low 4’s.
This people, is not the norm – in fact it is the lowest interest rates on record.
I find it crazy that people are jumping into their loans at the deepest end first, thinking that the good times will continue.
Let’s take our example, at 4% interest rate the interest-only (not even repaying principle) repayments are $3,334/month, at 5% it is $4,167, at 6% – $5,000, 7% – $5,834 and so on.
Mr Buffet said it best that it’s only when the tide goes out you find who’s been swimming naked.
My personal opinion is that during the last Sydney and Melbourne housing boom, plenty of owner-occupiers and investors have been swimming naked, rolling cigars with their paper profits.
The key saving Grace is that the policy makers and lever pullers at the Reserve Bank and Government bodies are well aware of this scenario (hopefully!) as to explain why interest rates are on hold for so long.
But whether in 1 year, 2 years, 3 years, 5 years, 10 years – however long – they will come back up.
Myself personally, I can still remember paying in the mid-high 7’s when I first started out…
Interest rates! Only takes a few months and BOOM – up goes your repayments by an extra grand each month – OUCH!
Coming back to our couple, mind you – these are all assumptions.
I don’t know this couple and I’m quite sure they don’t know me (although the wife did catch me listening in and suggested they move tables – not my proudest moment).
For all I know – they could both be on a pretty penny!
Million dollar mortgage? Hogswash! Who do I make the cheque out to?
In which case… Godspeed Sir and good luck Ma’am.
But if they aren’t on a pretty penny and want to “stretch” to make things work.
Well… I sure hope they consider what’s laid out above.
Because like all things in life – a bit of foresight and planning doesn’t go astray.
What do you think? Did you enjoy this post? Please help me out if you enjoyed this and click on the little “follow” button at the bottom right and be a follower. This way, you’ll never miss my words of awesomeness! So do the right thing, be a subscriber and get it straight to your inbox fresh out of the oven!