When I bought my first family home my buying journey was stereotypical.
We started looking at properties that were well within our means. Unfortunately, we didn’t like them. They weren’t big enough or good enough. They had too many compromises. We would have outgrown them too quickly.
So what did we do? Like any self-respecting aspirational home buyers we begged, borrowed, scrounged, and with the help of a great mortgage broker and some massaging of financials, weaselled our way into the biggest possible loan pre-approval that we could get.
And then we spent 15% more than that.
And while we may not be sitting on much equity in the short term, we have zero regrets because we love our home, it beats renting, and we fixed in most of our mortgage at below 2.0%
We might not feel so smug (or solvent) in two years’ time!
Nevertheless, in my experience, most buyers stretch themselves to get into the housing market or to upgrade.
Most buyers get the highest possible pre-approval and then spend all of it. And some.
It may not be financially prudent, but it’s human nature.
And when it comes to your principal place of residence, where you spend most of your (free) time, where you bring up your kids, and where you can create tax-free wealth simply by buying and holding long term, you can see why buyers stretch themselves.
The mortgage landscape has changed drastically in the past 12 months.
Borrowing capacity is being decimated by the most aggressive rate hikes Australia has ever seen.
Two-, three- and four-year fixed rates have jumped from less than 2.0% to well over 6.0% in a little over a year.
The cash rate is already up by 1.25% in the last three months. Many are predicted it to rise above 2.5% by the end of the year.
For the majority of Australians (two-thirds apparently) this is irrelevant because they either don’t own a property, or they don’t have a mortgage.
But for active buyers who are borrowing up to 80% of their purchase price, interest rates have a huge bearing on serviceability and, even more importantly, capacity.
Borrowing capacity is falling far more rapidly than house prices. (Like, by a factor of 10).
Our mortgage broker friends at Entourage sent us a communication recently with an example of a typical home buyer in Stonnington:
A family with two dependents and a combined annual income of $400,000 with average expenses, applying for a 30-year mortgage.
At an interest rate of 3.5% their borrowing capacity is $2,590,000.
At an interest rate of 6.0% their borrowing capacity drops to $2,035,000.
That is, a 2.5% increase in interest rates lowers their borrowing capacity by $555,000, or 21.4%.
This is a huge whack.
Given the trajectory of interest rate hikes this year, this is effectively a half a million dollar reduction in buying capacity within six months for this hypothetical buyer.
Another way of looking at this is that property prices would need to decline by 21.4% for this family to be able to afford the same house after the 2.5% rate hike compared to before.
While the media might like you to believe that such a precipitous fall in house prices is on the horizon, it isn’t.
Any house price declines will be modest and gradual compared to the rapid decline in borrowing capacity.
Theoretically, if today you are looking to buy in the $2,500,000 – 2,700,000 range, in six months’ time (or however long it takes rates to rise by 2.5%) you might only be able to afford a property in the $1,900,000 – 2,100,000 range, all other things being equal.
This is a very different proposition.
In our market, $500,000 in buying power can be the difference between a single front or a double front; the difference between 250sqm of land or 400sqm of land; the difference between a three bedroom or a four bedroom home.
Not many buyers are willing to compromise that much.
So what does this actually mean for buyers and sellers?
If you’re looking to buy or upgrade, is it really a smart move to wait and see what happens with house prices in the next six to 12 months if you aren’t going to be able to afford the house you want due to a significantly lower borrowing capacity?
Sure, the house that you like today might sell for $100,000 less next year, but your budget may reduce by $500,000 over that same time. So you will be well and truly priced out, even if house prices ease.
And if you’re thinking of selling, is it really a smart move to wait for several more rate hikes knowing that a proportion of your best buyers today will no longer be able to afford your house, and the ones who can afford it are probably still expecting to find something in their previous price bracket with the extra bedroom and bigger block?
Of course, this is just a thought experiment and everyone’s situation is different. (Please talk to your financial advisor and mortgage broker).
But as agents we are talking to buyers every day whose buying power is dwindling by the month.
Pre-approvals are being wound back by the banks with every successive rate rise… currently this means every month. And significantly.
There are many factors affecting demand and house prices right now, but this is one of the biggest ones and it is worth considering, as a buyer or a seller.