The Australian housing market is in a pretty remarkable state right now. House prices are at record highs whilst interest rates are at record lows. If you’re a FHB, there’s a damn good chance you’re having trouble getting a deposit together, finding the right house for the right price and then (hardest of all) outbidding all the other investors or existing home owners out there. If you have a house with a mortgage then you’ll likely be enjoying the rock bottom interest rates. And finally if you already own your own house outright… you probably don’t give a rat’s ass about the interest rates!
The thing with the economy though, is that when things are “at record highs” or “at record lows”… it doesn’t usually tend to be too good for the average person according to history. One simply has to remember the most recent financial crash in the US to realise this. Now I’m not saying that the Australian market is due for a similar correction (although I’m sure it would make a lot of FHB’s happy) but it does always pay to be well prepared for the most likely scenarios when we start to see these types of stresses being put on the Australian economy. We’re seeing the end of the mining boom, what appears to possibly be the end of the housing boom and the onset of consistent, global warming induced, natural disasters on a more regular scale. On top of all this, China’s economy is drastically slowing down which will no doubt have serious run on consequences for us too. So how well prepared are you?
For the below text I’ve assumed a few things. First is that things go bad. They might not go bad, but if they go good awesome, no plans really should be needed so for this piece I’m only considering what happens if the economy goes bad. Second, I’m assuming you have a mortgage (or are about to) as this is MTM. Lastly though, I’d like to point out that this is all just speculation on my behalf. I try to use plausible logic and draw on the knowledge of history but predicting the future (whilst fun) always ends up being wrong somehow as you can never predict everything. My goal is to simply get you thinking about the various problems that may arise and how you might best deal with them. As events unfold I’d encourage all of you to continue extrapolating and altering your plans to ensure you’re still doing as much as you can to prepare yourself for bad things to come.
Which Camp Are You In?
First off, pick one of the below “camps” that best suits your current situation. Everyone’s different and I’m sure many won’t fit exactly into one of the three options but it’ll have to do.
Camp 1: You’re a FHB that is either currently renting or living at home with your parents. You may or may not have a decent deposit saved up but ultimately you’re looking at hopefully buying a house soon.
Camp 2: You live in your own house, however you’re still paying down your mortgage. You don’t have any other investment properties.
Camp 3: You have a mortgage over both your Principal Place of Residency (PPoR) and an investment property.
What Could Happen To The Housing Market?
Whilst technically ANYTHING could happen… there a few scenario’s that are the most common throughout history. The housing market:
- Goes Up Quickly: The market starts to repeat the incredible boom period seen over the past decade with prices rising rapidly and steeply.
- Goes Up Slowly: The market continues climbing at a rate slightly higher than inflation. Given inflation over the past 10 years has been 2.9% according to ABS history, this would mean house prices would have to go up more than that.
- Stagnates: The market continues climbing at the exact rate of inflation (again, around 2.9%). This gives you a 0% real return and a positive nominal return even though the money value of your house “goes up”. This is also called stagnation or “going nowhere”.
- Goes Down Slowly: The market starts declining in value. This can occur in two ways, the price of houses can start to go down, resulting in both negative real and nominal returns or the price of houses can simply stay the same whilst the price of everything else inflates around it. This results in a negative real return and zero nominal return rate. To learn further about the differences of real and nominal returns see here.
- Goes Down Quickly: The market (or whole economy more likely) suffers a serious shock and house prices decline rapidly and steeply. Another alternate version of this is where there are smaller declines in house prices, but over a very extended period of time (say 10 years) similar to what happened in Japan.
The Best Pre-emptive Action For Your Camp
If you’re a FHB trying to buy a house things have been hard for a long time. Ever since house prices started getting into the six plus multiples of the average Australian wage (>$400,000 or so) it’s be a big scramble between government bonus’, rapidly increasing prices and fierce competition. Given that scenarios 1-4 above all require you to have a very sizable deposit, I’d highly recommend focussing all your efforts on saving hard. Yes house prices may go down quickly… but there are significant vested interests trying to prevent this. Also, if it DOES happen and house prices halve in value overnight… you’ll have a great deposit built up and ready to strike. Just don’t go out and buy a house that’s twice as much, buy the SAME house and use that lower price to give you a smaller mortgage.
Regarding building up a sizable deposit (think 15%-20%) there are many tips on this website on how to reduce expenses and become more efficient. Granted a lot might not apply to you if you’re living at home, but if you’re renting they will be very helpful to eke out that extra savings amount. Furthermore, consider reading up on and using the Australian First Home Savers Account (FHSA). Whilst these accounts do have some restrictions on them, you can simultaneously get a good interest rate return on your savings whilst also getting free contributions from the government (woot free money!). Be sure to read the fine print on them though as there is a minimum time frame on when you can take the money back out.
Once you’ve gotten into the habit of saving hard (say 30%-50% of your after tax income) it will very easily roll over to mutilating your mortgage. At the same time though, do be aware that house prices are very unaffordable here in Australia. The calculations are very dependent on location, personality type, lifestyle and so on, but sometimes it is smarter to rent than buy. The key thing to remember with this option though is to take the money you save (the mortgage payment – the rent payment) and invest it in something like shares or bonds using a well diversified portfolio. If you don’t have adequate investing knowledge I’d likely advise against this option.
If you’re living in your own house with a mortgage over your head the best bet (regardless of which of the above scenario plays out) is to do what it appears most Aussies are doing: pay down your debt. You’re here at MTM so you’re off to a good start! Track your expenditure and mortgage repayments, cut back on things that are useless, stop being a complaineypants and aim to hit that 70% after tax savings rate! If you think it’s impossible – it’s not. Many people already do it (including us) and many go even further than just 70%. You likely don’t hear about it very often (mainly because few people discuss finances) but it’s not that hard a thing to do. Yes it’s easier if there’s two incomes or high incomes but still aim for that goal, you may surprise yourself. If you’re a single person earning $60,000 a year before tax no one’s going to yell at you for not being able to put away $34,267.10 each year on your mortgage (that’s 70% of after tax income on $60,000). Try and aim for it anyway, if you manage to “only” pay off $30,000… well guess what? That’s freaking AWESOME! You’ve crushed 99% of all other people in your situation who are also trying to pay off their mortgage. You’re getting ahead a LOT.
In all above scenarios paying down your debt steadily puts you in a less and less precarious position in life. If the economy tanks and your job gets cut guess what? You’ve got a $30,000 buffer on your home loan to help you tread water while you get another job. If interest rates start to climb back up to 1990 level rates (think 17%!) you’ll be in a MUCH better position with your greatly reduced mortgage. So batten down the hatches, buckle up and kill that debt. Once you’ve cleared it, then comes the time for fun.
The superior man makes the difficulty to be overcome his first interest; success comes later
When you have multiple mortgages it means there’s a good chance that you’re even more exposed to things if the market goes south. A drop in interest rates might be helping the ROI on your investment property… but an unstable economy could also take the job of your renter, cutting off your income full stop. If house prices go up slowly or even quickly it will likely be a good day for you. It normally makes more sense to pay off your PPoR first though due to the negative gearing rewards you get from paying interest on your investment property. If the market stagnates you would again be best to try and pay off your PPoR mortgage first and if things start to go down slowly (or quickly) I’d be trying to (you guessed it) pay off that PPoR ASAP.
A Unified Answer
Now although that’s a lot of talk to essentially just say “pay off your mortgage quicker” I feel it’s good to fully go through it all so everyone can get a good grasp on what could happen, what is happening and how that can affect their individual situation. Sure, my opinion (and everything is my opinion here don’t forget) is that we should all pay down debt (or save aggressively) but it also makes a lot of financial sense too, regardless of what you’re doing.
When you reduce your debt your options open up. You have more flexibility, you have more degrees of freedom and you are better able to withstand the financial shocks that life will throw your way. Too many people get “wiped out” but leveraging themselves up too high. Sure, you might be able to borrow $700,000 to buy a home… but you’re setting yourself up to be in a far more precarious position for a number of years. Years where you effectively become a wage slave to your job. This affects your life, your ongoing attitude, your family, your spouse, your friends, everything. A financially stable foundation is key to getting ahead in this world. It enables you to take decisive action when true opportunities present themselves and it protects you when things are tough.
So how hard is your hat?
The benefits include: 1) How to pay off your mortgage faster than 99% of people with one hour a month of work 2) How to get rid of your debt and have the freedom to spend money on the things you love, guilt free 3) Clear outline of how to setup your expenses, mortgage and general finance 4) How offset accounts work and how to get the same result without being gouged by the big banks 5) How to cut through the crap and focus on the things that truly matter when taking down a mortgage 6) How to adjust the strategy so it works for you, even if you have kids, even if you only have one income 7) How to do all of these things and maintain a normal social life (and never be cheap).