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One in five homeowners will struggle with rate rise of less than 0.5%

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ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent.

Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.

But as we scramble over each other to snap up property while interest rates are at historic lows, we have gotten ourselves into a bit of a pickle. We might not actually be able to afford funding our affair.

An analysis, based on extensive surveys of 26,000 Australian households, compiled by Digital Finance Analytics, examined how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. And the results are distressing.

It showed that around 20 per cent — that’s one in five homeowners — would find themselves in mortgage difficulty if interest rates rose by 0.5 per cent or less. An additional 4 per cent would be troubled by a rise between 0.5 per cent and one per cent.

Almost half of homeowners (42 per cent) would find themselves under financial pressure if home loan interest rates were to increase from their average of 4.5 per cent today to the long term average of 7 per cent.

“This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards,” Digital Finance Analytics wrote.

The major banks have already started increasing their home loan rates this year, despite the market broadly expecting the Reserve Bank to keep the cash rate steady at 1.5 per cent this year.

Just this week NAB upped a number of its owner-occupied and investment fixed rate loans.

“There are a range of factors that influence the funding that NAB — and all Australian banks — source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said of the announcement.

“The cost of providing our fixed rate home loans has increased over recent months.”

So as interest rates rise and leave mortgage holders in its dust, it leaves a huge section of society, and our economy, exposed and at risk.

NOT TERRIBLY SURPRISING

Martin North, Principal of Digital Finance Analytics, said the results are concerning, albeit not surprising.

“If you look at what people have been doing, people have been buying into property because they really believe that it is the best investment. Property prices are rising and interest rates are very low, which means they are prepared to stretch as far as they can to get into the market,” Mr North told news.com.au.

But the widespread assumption that interest rates will remain at historic lows is a disaster waiting to happen, especially in an environment where wage growth is stagnant.

“If you go back to 2005, before the GFC, people got out of jail because their incomes grew a lot faster than house prices, and therefore mortgage costs. But the trouble is that this time around we are not seeing any evidence of real momentum in income growth,” Mr North said.

“My concern is a lot of households are quite close to the edge now — they are not going to get out of jail because their incomes are going to rise. We are in a situation where interest rates are likely to rise irrespective of what the RBA does … There has already been movement up.”

Australia’s wages grew at the slowest pace on record in the three months to September 2016, according to the latest Wage Price Index released by the Australian Bureau of Statistics (ABS).

And as a result Australia’s debt-to-income ratio is astronomical. The ratio of household debt to disposable income has almost tripled since 1988, from 64 per cent to 185 per cent, according to the latest AMP. NATSEM Income and Wealth report.

What this means is that many Australian households are highly indebted, thanks in large part to the property market, without the income growth to pay it down.

“The ratio of debt to income is as high as it’s ever been in Australia and there are some households that are very, very exposed,” Mr North said.

THE YOUNG AND RICH MOST AT RISK

This finding will come as a surprise: young affluent homeowners are the most at risk — it is not just a problem with struggling families on the urban fringe. When it comes to this segment of the market, around 70 per cent would be in difficulty with a 0.5 per cent or less rise. If rates were to hike 3 per cent, bringing them to around the long term average of 7 per cent, nine in ten young affluent homeowners would feel the pressure.

“It is not necessarily the ones you think would be caught. And that’s because they are actually more able to get the bigger mortgage because they’ve got the bigger income to support it.

“They have actually extended themselves very significantly to get that mortgage — they have bought in an area where the property prices are high, they have got a bigger mortgage, they have got a higher LVR [loan-to-valuation ratio] mortgage and they have also got lot of other commitments. They are usually the ones with high credit card debts and a lifestyle that is relatively affluent. They are not used to handling tight budgets and watching every dollar.”

And while the younger wealthy segment of the market being most at risk might not be of that much importance compared to other segments, Mr North said what is concerning is the intense focus on this market.

“Any household group that is under pressure is a problem for the broader economy because if these people are under pressure they are not going to be spending money on retail and the broader economy,” Mr North told news.com.au.

“The banks tend to focus in on what they feel are the lower risk segments and the young affluent sector has actually been quite a target for the lending community in the last 18 months. Be that investment properties or first time owner-occupied properties, my point is there is more risk in that particular sector than perhaps the industry recognises.”

TOUGHER HOME LOAN RESTRICTIONS NEEDED

Now an argument is mounting that Australian banks need to toughen up their approach to home lending.

“I think we have got a situation where the information that is being captured by the lenders is still not robust enough. I am seeing quite often lenders willing to lend what I would regard as relatively sporty bets … I’m questioning whether the underwriting standards are tight enough,” Mr North said.

This includes accepting financial help from relatives for a deposit, a growing trend among first home buyers.

“The other thing that I have discovered in my default analysis is that those who have got help from the ‘Bank of Mum and Dad’ to buy their first property are nearly twice as likely to end up in difficulty … It potentially opens them to more risk later because they haven’t had the discipline of saving.”

News.com.au contacted several banks for comment on whether they think a rethink of their underwriting standards is needed. Only one lender, Commonwealth Bank, agreed to comment, but remained vague on the topic.

“In line with our responsible lending commitments, we constantly review and monitor our loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs. Buffers and minimum floor rates are used when assessing loan serviceability so it is affordable for customers,” a CBA spokesman said in an emailed statement.

But Mr North said something needs to be done before we find ourselves in a property and economic downturn.

“I’m assuming that with the capital growth we have seen in the property market, it will allow people who get into significant difficulty to be able to get out, however, it’s the feedback concern that I’ve got.

“If you have got a lot of people in the one area struggling with the same situation, you might see property prices begin to slip. If we get the property price slip, and we get unemployment rising and interest rates rising at the same time, we have that perfect storm which would create quite a significant wave of difficulty.

“We need to be thinking now about how to deal with higher interest rates down the track. We can’t just say it will be fine because it won’t be,” he told news.com.au.

 

Originally Published: http://www.goldcoastbulletin.com.au/

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Finance

CBA axes SMSF home and office property loans amid growing market fears

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CBA, the nation’s largest mortgage lender, is axing residential and commercial loans for self managed super funds amid growing concerns about regulatory problems, property market weakness and stricter capital adequacy rules squeezing returns.

The bank is set to announce it is pulling SMSF lending product, SuperGear, in a bid to “become a simpler, better bank and streamline our product range”, from October 12.

Westpac Group, the nation’s second largest mortgage lender, pulled out of the sector in July making similar claims about wanting to “simplify and streamline” its product range.

But the moves will shock mortgage brokers and financial advisers and make nervous property investors more jittery about the outlook amid falling prices, rising costs and oversupply, particularly for apartments in the inner suburbs of Melbourne, Sydney and Brisbane.

It is also being done during a period of increased regulatory scrutiny of leveraged superannuation assets, potential reputational risks to lenders and advisers from “high risk” single investment SMSF schemes, and lenders’ capital adequacy requirements.

“CBA has decided to withdraw its SMSF lending product that allows SMSF trusts to purchase both residentially and commercially secured properties,” a spokesman said.

“This is part of our strategy to become a simpler, better bank. We are streamlining our product portfolio and have decided to discontinue SuperGear.”

Support existing accounts

The bank said it will be writing to customers who hold a SuperGear loan outlining the changes.

It will continue to support existing loan accounts.

“We are seeing the writing on the wall for leveraged SMSFs,” said Sally Tindall, director of research for RateCity, which monitors rates for financial service products. “This calls into question the viability of the leveraged SMSF sector.”

Regulators fear problems arising from SMSF investors leveraging their superannuation to invest in a single residential property because of the lack of diversification and increasing dangers of loss in a falling property market where it is difficult to find tenants. Systemic risk is low because the loans are non-recourse, which means they are secured by the property.

The Australian Taxation Office and Australian Securities and Investments Commission are targeting the use of SMSFs to invest in property after a review revealed 90 per cent failed to comply with “best interests” tests and other legal obligations.

It warned the strategy of gearing through an SMSF to invest in property, which is heavily promoted by property seminars and “property one-stop shops”, is risky.

The one-stop shops typically involve real restate agents, developers, mortgage brokers, accountants and financial advisers.

A key finding of the David Murray-led financial system inquiry in 2014 was that leverage should be banned in superannuation funds to mitigate the risk of financial instability. The government rejected his advice and Mr Murray said that was a mistake.

Mr Murray, who was recently appointed chairman of AMP, the nation’s largest financial conglomerate, is expected to launch an internal review of its SMSF lending practices.

Banks are also believed to be quitting the sector because of increased capital adequacy requirements by the Australian Prudential Regulation Authority are squeezing profits.

Legal restrictions

The greater complexity associated with SMSF loans and relatively small size of the market are also disincentives, according to analysts.

“As banks are looking to streamline and reduce costs, these are the types of products that get reduced,” he said.

There are fears that legal restrictions – or caps – on how much an SMSF investor can contribute to their plans could cause a credit crunch for many borrowers and force fire sales of their properties, which becomes more likely as property capital values and yields slump.

This scenario could arise if the expense of renovating a property, or supplementing rental income, exceeded annual caps.

Lenders are also lowering their lending book risks by increasing scrutiny of borrowers’ income and expenditure in assessing their capacity to repay.

Other major lenders are also tightening their SMSF lending policies in addition to increasing rates on loans and other property-related credit.

Nearly $700 billion is held in SMSF funds by more than 1 million investors. During the past four years the number of members investing in property has increased from about 3.6 per cent to 6.9 per cent of SMSF fund assets.

Source: Afr.com

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Finance

How to cope with interest rate rises

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Tighter regulations and slowing credit growth are forcing financial institutions, including Westpac and Suncorp, to increase their variable interest rates. These increases come when the drought and a weakening property market are reducing the prospects of continuing growth in key sectors of the economy.

As a result, the Reserve Bank has been reluctant to increase the official interest rates from the present historically low levels to more normal levels. With rates rising offshore and continuing political uncertainty, the cost of overseas short-term funding for our major banks has increased even though the official cash rate hasn’t changed.

The increased costs arising from the regulatory charges and the ongoing banking Royal Commission have also helped trigger the variable interest rate increases. Borrowers now face the unusual situation of rising interest rates when property prices are falling.

Westpac and Suncorp’s variable interest rates have risen.

Photo: Fairfax Media

The prospect of major changes to the taxation of property investors isn’t helping investor confidence. But for those contemplating new borrowings the tightened regulations are limiting the amount that can be borrowed as well as lengthening the time needed for loan approval.

Both factors have been restricting the ability of potential purchasers to acquire properties and for vendors to achieve good prices. Given the importance of property construction to continuing strength in the economy, the Reserve Bank is unlikely to add to developers’ problems by increasing the official interest rate.

If anything, the Reserve Bank will face pressure to reduce the official rate to help the banks and property sector. The increase in interest rates for borrowers has been relatively small and can be financed in some cases by reducing repayments of principal. Borrowers who’ve taken advantage of lower rates to reduce their outstanding loans can make this choice.

One major bank has already responded to the slowdown in credit growth by informing existing clients about the possibility of reducing their minimum monthly repayments. However, taking advantage of this option increases the risks of being adversely affected by any future rate rises.

Indeed, the current interest rate increases are a warning that further increases are possible. Continuing to repay capital as quickly as possible is a way to reduce risks and build wealth even with investment loans where the interest payments are tax deductible.

Not paying off an investment loan makes excellent sense when there’s also an owner-occupied home loan in existence. In this case, paying off the home loan first reduces non-deductible interest outlays. When the only loan is an investment loan, paying off the principal still makes sense, especially when property prices are falling. Owning an investment property with little or no debt allows the owner to take a long-term view and sit out downturns in values or periods of vacancy.

Source: www.brisbanetimes.com.au

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Finance

Why equity can help you buy again

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Why equity can help you buy again

Unlocking the equity in your home could help you purchase another. Chief executive of property advisory firm Property Mavens used her home’s equity to buy a Preston investment property. Picture: Lawrence Pinder

WE’VE all heard of the benefits of refinancing to get a better deal on your home loan, particularly a more competitive interest rate.

But what if refinancing could also help you buy an investment property?

“Borrowers may be able to refinance their existing home loan to access equity they may have built in their property, in order to buy an investment property,” Mortgage Choice chief executive Susan Mitchell said.

Refinancing with the aim of buying an investment property could allow borrowers to grow their wealth, according to Ms Mitchell, as, generally speaking, property was considered a safe asset class in Australia with decent returns over the long term.

“CoreLogic found that over the 10 years to June 2018, national dwelling values increased by over 40 per cent, a good return on investment,” she said.

But she cautioned there were a number of costs associated with refinancing, so it was important borrowers made an informed decision before jumping in.

Why equity can help you buy again
Leveraging your home’s equity could help you to buy another.

The nuts and bolts

So, how does refinancing using equity work?

The Successful Investor managing director Michael Sloan explained that lenders would typically lend you 80 per cent of the market value of your home, less the debt you still owed against it.

“This is your usable equity as banks hold some back as security,” he said.

“So, say, for example, you have a $500,000 property and a $200,000 loan. Your usable equity will be $200,000,” he said.

As to what value investment property you could buy, Mr Sloan said a simple rule of thumb was to multiply your usable equity by four.

“But remember that one of the risks of property investing is spending too much,” he said.

“You need to buy well below the median house price ($742,000 in Melbourne, according to CoreLogic), in fact you shouldn’t be within $200,000 of it.”

Ms Mitchell said the figure depended on how much a lender determined a borrower could afford to repay.

“Available equity is important but the key factor a lender needs to consider is how much a borrower can afford,” she said.

“If a borrower does not have additional capacity to repay a proposed new loan, they may not be able to borrow, irrespective of how much equity they may hold,” she said.

Why equity can help you buy again
Consulting an independent broker may be helpful for would-be investors.

Where do I sign?

And there’s the rub: having equity in your home is not a guarantee you’ll be able to access it.

“You can have a million dollars of equity but if you don’t satisfy the institution’s lending criteria, they are not going to loan you any money,” Mr Sloan said.

“The bottom line is they will take everything into consideration: for example, how many children you have, as the more you have the less you can borrow, your work situation and how much you spend on everything from your daily coffee to the tyres on your car.”

Lenders have also tightened their assessment procedures as a result of recent regulatory measures, such as The Australian Prudential Regulation Authority (APRA) imposing a 10 per cent benchmark in growth on investment lending last year.

This was introduced in a bid to curb activity in the housing market, Ms Mitchell said.

“These regulatory measures have resulted in lenders increasing their scrutiny of a borrower’s ability to service a loan,” she said.

“When deciding if an applicant can afford a mortgage, a lender will consider a borrower’s available ongoing income and from this allow for existing debt commitments and living expenses,” she said.

“Their decision will also factor in a buffer for potential increases in interest rates.”

But it’s not all doom and gloom. Ms Mitchell advised that borrowers could overcome the increased scrutiny by getting “financially fit”.

“Get out of debt, spend your money wisely and adopt a disciplined savings strategy to show lenders you can service a loan,” she said.

Air Mutual director Damien Lawler advised would-be investors to consult an independent broker who could access a range of lenders, which might have varying assessment procedures.

“Everyone is talking about the banks tightening up – which they are – but there are banks, particularly the smaller, tier-two banks, who are still lending,” he said.

Why equity can help you buy again
Getting the right structure for your loan is essential.

And finally …

Mr Sloan said his No.1 piece of advice for would-be property investors was to play it safe and to have some funds in reserve if things go wrong.

“You should never buy (another) property if you have no extra money available to you after you settle, so you need to have a buffer. And protect what you are building with income protection and life insurance, if you have a partner,” he said.

Source: www.sunshinecoastdaily.com.au

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