A further $310-a-month extra on home loan shock looms

Posted by Henry | HOME LOANS,INTEREST RATES,MORTGAGES | Tuesday 10 March 2015 9:43 am

Borrowing big while mortgage rates are low could secure your dream home. But when interest payments  move off the bottom you might find you're struggling to stay afloat.

Borrowing big while mortgage rates are low could secure your dream home. But when interest payments move off the bottom you might find you’re struggling to stay afloat. Photo: Louise Kennerley

Heard the trendy social term F.O.M.O, the Fear Of Missing Out? It’s a compulsion now so rife among would-be property buyers they’re giving themselves debt hangovers that will last a lifetime. And I feel compelled to warn them (and you) about the $310 monthly repayment risk.

The apparently intoxicating facts are:

  • Property prices that seem to forge ever upwards,
  • Sky-high auction clearance rates, and;
  • Interest rates at record lows.

That’s all pushed the average loan size to an all-time high of $342,100, says the ABS, 10 per cent above that of two years ago and 7 per cent more in the past four months alone. And for many Sydneysiders or Melburnians that will seem like small change.

More are borrowing it, too.

Both Westpac and ANZ report loan applications are up since the February rate cut and for today’s cheapest lender, loans.com.au, they’ve doubled. Anecdotally, the increased demand has fuelled lender reluctance to discount

Before you join the throng, though, please realise these are abnormally low, once-in-a-lifetime interest rates. And the usual mortgage lasts for 25 years of rate cuts and – you can bet – rises.

Remember the credit crack-up of 2008 and how everything was so dire rates were “never” going up again? Barely more than a year later they rose six times in eight months.

In October, November and December 2009 and again in March, April and May 2010, the RBA raised the cash rate, by 0.25 per cent each time. In a short eight months, the official rate rose from a post GFC-low of 3 per cent to 4.5 per cent.

Were that to happen at today’s average $342,100 loan size, borrowers would need to find an extra $310 a month as their repayment leaps from $2000 to $2310 in just over half a year. That’s more than $3700 extra each year. (Based on the average discounted Big Bank rate moving from 5 per cent to 6.5 per cent.) It’s budget-breaking stuff.

If people thought the 2009, post-crisis rises were painful, the average loan at that point was 16 per cent less at $287,300 so the impact was only $272 extra a month, or $3264 a year (the average rate moved from 6 per cent to 7.5 per cent).

But a rebound all the way to pre-GFC levels would represent a doubling of rates. Today’s borrowers would need to find an extra $1110 every month, or more than $13,000 a year. (Average mortgage rates would double from 5 per cent to 10 per cent).

Loan sizes are now so high that on average two hikes requires more than $100 extra a month, $1200 a year. For each $100,000 you borrow, every rate rise means $15 more out of your pocket. If (or probably when over a 25-year period) rates go back up, could you handle the repayment shock?

Find your safe borrowing ceiling (regardless of what a lender tells you it is) with these two simple steps.

  • 1. Multiply your deposit by five This is what you can afford to pay for a property if you borrow only 80 per cent. For example, if you’ve saved $50,000 you would be looking for property priced at or below $250,000. Remember an 80 per cent loan cap not only means you avoid extortionate lenders’ mortgage insurance, but you have an equity buffer if property prices fall, a big consideration when affordability is back at all-time lows (Barclays research). Weigh up carefully the next equation if you are tempted to borrow more.
  • 2. Multiply your annual before-tax salary by 0.333, then divide by 12 months This shows the monthly repayment you should be able to afford today. Jump on Money’s borrowing power calculator, plug in 5 per cent and check what size loan this would get you. But with rates at never-to-be-repeated lows, you also need to ensure you could afford repayments should they rise. “Stress test” your repayments for eight hikes or a 7 per cent interest rate (post-crisis, mortgagees copped seven rises in just one year), and more. How would you cope?

“Helpful” people will tell you property doesn’t ever go down so it’s OK to borrow a lot – it does and it’s not. Especially at housing highs and interest-rate lows. Don’t be seduced by F.O.M.O’s crazier cousin Y.O.L.O. – You Only Live Once.

The urban dictionary defines this as “The dumbass’s excuse for something stupid that they did.”

You can’t afford this to be you.

NB for all figures I have assumed an average mortgage rate 2.75 per cent above the official rate.

Nicole Pedersen-McKinnon

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Henry Sapiecha

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