BDO in Brisbane Partners, Hung Tran and Eddie Chung, provide responses to industry queries raised during the recent BDO Business Outlook 2019 event.
Question: A bank in Denmark has recently offered negative interest rates for home loans. What are the impacts of negative interest rates will it ever occur in Australia?
In our view, there are quite a few things that have to happen before home loan interest rates would get into negative territory in Australia. Even if the RBA cuts the cash rate to zero, banks would still need to charge a margin of up to, say, 3% to keep their profit position, so there are still a number of hurdles the economy has to jump over before we would see negative interest rates for home loans in Australia.
Theoretically, in a negative interest rate environment, home owners may come out of the woodwork as their serviceability increases. Having said that, there would still be those who may still not qualify for a home loan and stay as renters.
On the other hand, negative interest rates would erode or even remove the tax benefits of negative gearing for investors who invest for tax reasons, so those investors may leave the market. To balance this off, there will always be those investors who look for investment yield, which will increase under a negative interest rate environment.
All in all, a negative home loan interest rate environment is unprecedented in Australia, so we can only speculate on how it would affect the property market.
Question: I recently heard that a major bank will now not rely on 3rd party guarantees for approvals. How will this affect young people getting into the housing market?
We have not seen instances of this in our client base but we query why banks would want to do this because, at the end of the day, lending for property investment is all about risk and return. As long as banks can reduce risks, whether it is through a mortgage or a third party guarantee, and provided that the serviceability requirements are met, it is difficult to see why the banks would reject the application.
However, there would still be ways around this policy should this ever become a common occurrence. For instance, the third party may own, say, 1% of the property and have their name on the property title, which brings them into the primary security net.
Questions: How do you think young Australians entering the housing market should approach it?
Entering the market largely comes down to the individual.
For some, buying a property is not about location or lifestyle; it is solely about growing their asset base. These individuals save up their deposit and enter the market at a price point that they are capable and comfortable with buying.
On the other hand, others may have lifestyle requirements they wish to fulfil in buying their property. Some of these individuals may claim they cannot afford to buy but what they really mean is – they cannot afford to buy in a particular suburb or area they desire. If these individuals are serious about getting into the property market, they may have to readjust their expectations.
It is important for first home buyers to remember that if they want to get into the market, they may have to exercise financial discipline, make sacrifices, and take a delayed gratification approach. They need to be cautious of low interest rates and resist the temptation of spending more than they can afford simply because loan repayments are lower. The property market is unpredictable and interest rates may change – we recommend potential buyers stress-test their ability to repay the loan at two or three times the current interest rate to give themselves plenty of buffer.
Also, if interest rates go down, it may be advisable to leave their current level of loan repayment amount intact, which is tantamount to an enforced saving plan and provides a buffer if interest rates go the other way. Remember that the more you pay down the loan, the more you are reducing your financial risk. If you are starting out on the property market, your home is a lifestyle asset, so it is important to know that you are lowering your risk along the way.
Question: How do older people get into the housing market if they have rented all of their lives?
If the older person has been paying rent for all of their life, hopefully, they would have put aside some money as personal savings. After all, rent generally tends to be lower than mortgage repayments. Those personal savings may become the equity contribution for the property purchase to satisfy the bank’s security requirements.
If there is no such personal savings set aside and no hefty inheritance is coming your way, it may perhaps be time to construct a personal budget that provides periodic savings, which would eventually become down payment for the property purchase. Banks would generally lend up to 80% of the value of the property without any lending mortgage insurance, so you would need to come up with an equity contribution of 20% of the value of the property. With insurance (which may generally be added to the loan principal), banks may lend up to 95% of the value of the property. In which case, you would only need to come up with an equity contribution equating 5% of the value of the property.
In some ways, renting long-term may actually be an advantage for the older home purchaser because paying rent consistently demonstrates the ability to make periodic payment and therefore future mortgage repayments. Any older person may also have higher borrowing capacity because one tends to earn more as they get older.
On the other hand, financially undisciplined individuals who are older may have issues getting a loan, especially for those who have children and therefore a higher cost of living. This is where it is especially important to be proactive with your finances – understand where your money is going and live within your means by way of a personal budget.
Another key consideration is whether your expectations are realistic. While you may aspire to own a house on a large block of land, it may be more financially sensible to buy a townhouse instead just to get you through the door of home ownership. Buying the worst house in the best street is still a good strategy. It is the quality of the asset that is important to ensure that your property would increase in value over time.
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