COMMENT: House prices over the past year have, quite unexpectedly, risen a huge amount. It’s about this time in the cycle that we often start to hear “no one will pay that” and “it’s just not affordable”. And yet the Reserve Bank is concerned enough with the state of the market to step in with LVR restrictions and threats of other policy changes.
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So with the market so hot, why haven’t the buyers just stopped putting in offers?
Before we progress any further, I want to state that, even though I own property, I’m not in favour of the relentless increase in property prices. This article is simply to show the numbers behind the continued queues at open homes despite ever-increasing prices.
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Let’s take an example of a couple, first home buyers, who had their eye on a $900k property last year but didn’t quite have enough deposit to get to the minimum 10% ($90,000) threshold. They have returned to the market a year later and discovered that the same house is now $1m. I know in most cities it’s probably more but for easy calculations, let’s say $100,000 increase. You’ll get the idea no matter what percentage the local market has increased.
The couple were looking to borrow $810,000 and now require $900,000 (being 90% of the new $1m price). In other words, they need to borrow an additional $90,000. How much additional income would a couple need to be able to afford the extra borrowing? We can quickly calculate this using some back-of-the-envelope maths.
We know the bank requires clients to be able to pay the mortgage at 7% on principal and interest terms. This could be estimated to be about $7,200 per year for $90,000 meaning that if the couple were at their income-affordability limit last year, they would need to have had a salary raise of around $5 per hour to keep up. Not outrageous and especially when you remember we are talking about a couple, so each person therefore only needed an extra $2.50 per hour before tax to still be able to afford the new mortgage.
This is the crux of why buyers aren’t exiting the market. Yes, properties might have gone up by $100,000 but a couple, both on a salary, only need to have gone from, say, $45 per hour to $47.50 per hour to still be able to afford today’s properties.
But what about the deposits? They require an additional $10,000 deposit just to meet the bare-minimum 10% and prices are rising so quickly that savers are struggling to keep up.
In this example, the additional $10,000 deposit required means an extra approximately $200 per week or $100 per person per week. For some people, that would be an achievable extra amount to put into savings in order to at least keep up with increasing property prices.
Property is a leveraged investment, meaning that big increases like $100,000 extra in purchase price means comparatively smaller required salary increases ($2.50 per hour per person for a couple) and reasonably small additional savings ($100 per week per person for a couple).
I know, for people just starting to look at getting on the ladder, the deposit and income requirements are astronomical - how do you quickly save $100,000? But you can see how buyers who were almost there last year aren’t necessarily out of the running this year, which goes some way to explain why buyers haven’t stopped putting bidding in this hot market.
*All numbers are rounded for simplicity and may vary depending on your individual circumstance. Numbers are not meant to indicate affordability levels.
- Rupert Gough is the founder and CEO of Mortgage Lab and author of The Successful First Home Buyer.
