The three year old bomb under that house you just bought

As we know, the Reserve Bank pandemic discount sale is having a wild effect on the housing market, but what is less known is that it is a bomb that will explode in three years.

In addition to cutting the cash rate to 0.1 percent, the RBA is providing virtually unlimited three-year funding to banks, also at 0.1 percent. This is called the “Term Finance Facility” (TFF).

The TFF is due to end in June, but JobKeeper’s end on Sunday could see it extended if, as expected, 150,000 people lose their jobs on Monday.

The RBA says it is trying to produce a tight labor market, but the government is shrinking it.

Right now the banks are using a lot of money for three years at almost zero interest.

The only challenge is to get the money out as quickly as possible and make a profit over three years.

As a result, three-year fixed mortgage rates have collapsed, which is the main driver of the current spike in house prices.

Record rates

In just over 10 years, the three-year average fixed rate has fallen from 1.5 percent above the average variable rate to 1.5 percent below.

The share of new fixed mortgage loans rose from 5% to 35%, a far record.

This means that in three years a huge housing debt will be refinanced, either at the current variable rate or at a new fixed rate.

This is also when the RBA says interest rates will be increased afterwards. Indeed, the RBA removed the pin from a slow grenade.

For now, however, these are happy days.

While total housing debt has increased from 120% to 140% of disposable income over the past 10 years, repayments have halved from 10% to 5% of income.

But the aggregate statistics, which are now a few months old, don’t quite reflect what is happening with auctions across the country after the latest round of fixed mortgage rate cuts by banks.

A three-year fixed rate mortgage now costs 1.89% interest from Westpac, the lowest of the big banks. Smaller, more aggressive banks charge even less.

This means that a family with a total after-tax income of $ 100,000 per year, or $ 8,333 per month, can afford a mortgage of $ 700,000 while keeping repayments at 30% of take-home pay, as recommended. .

Ten years ago, when the average three-year fixed rate mortgage was 7%. 100, the same couple could only borrow $ 350,000.

In other words, their purchasing power has doubled in a decade.

What is a house worth?

For most people without a solid inheritance, the only way to build wealth, or financial security at all, is to buy a home, so it’s the super second home first, as Tim Wilson recommends, the federal deputy for Goldstein.

But what should you pay for a house? Well, it’s both imprecise and liberating.

Super funds value the assets they buy using proven and reliable arithmetic: you estimate future cash flows – profit for a business or lease a commercial property – and calculate the present value of that.

A simplified way to do this is to take that year’s profit or rent and pay a certain multiple of it, depending on its security or rapid growth.

The long-term average in the sharing market is around 15 times the profit for the current year, although it is higher than that at the moment, and it is around 20 to 25 times for commercial real estate. .

But the house in which you are going to raise a family? The only arithmetic available to value this asset is what you can afford, so it’s what everyone else is using.

In other words: residential property is fully valued based on mortgage payments versus after-tax income.

Investors also use this method because they plan to sell to someone who will be living there, so the same valuation method applies.

This means that the value of residential housing is simply the inverse of interest rates, nothing more, and now that interest rates are microscopic, their converse can be gigantic.

On Thursday we find out what happened with house prices in March and loans in February. It is likely to be big.

In February, the national average price rose 2.1 percent; it could be double in March. In January, home loans increased 10.5% in a month and 44% in a year to a record high of $ 29 billion. It will likely be even higher in February.

And somewhere between a third and a half of those loans will need to be refinanced in three years, around the time the RBA says it will raise interest rates.

Tick, tick, tick …

Alan Kohler writes for The new daily twice a week. He is editor-in-chief of Eureka Report and financial presenter on ABC News

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