Beware of the Bubble

Posted by Josh Dolan on Oct 23, 2017 4:31:47 PM

Make no mistake; Australia is in a housing crisis. According to a recent study, shortage of available houses has lead to Sydney becoming the world’s second most expensive property market. Capital Economics expert Paul Dales has calculated houses in Sydney are currently 30% overvalued, and Melbourne’s are not far behind at 25%. The average price of a house in Australia was recorded as $656,800 earlier this year, and that number was the result of a $25,400 increase from the previous quarter. In order to receive a home loan, first homebuyers are expected to cover the cost of the initial house deposit. Whilst it fluctuates frequently, recent required deposits have been as much as 20% of the total house costs. This is an up-front payment of $130,000 for an average price house in Australia.

These trends are making it exceptionally difficult for new homebuyers to break into the market as houses are simply too expensive. To make matters worse, recent movements from banks overseas have seen Australian economists predicting an increase in interest rates locally. Some current borrowers have taken heed, with the amount of fixed interest-rate loans increasing to 27.81%.

Buying a first home was once an exciting time in one’s life, but now it often comes results in feelings of anxiety and stress related to financial strain: according to the Australian Bureau of Statistics, 3 out of 10 households are now over-indebted. This number is on the rise as an increasing amount of Australian homebuyers fail to meet their mortgage repayments. The current situation is greatly benefitting those who are already established within the real estate marketplace. Those who already own houses are benefiting from a 12.5% increase in rental demand, and they have the required capital to bid for new properties. This is causing renters to suffer an average weekly rent rise of $50, from $285 to $335. Housing investors are putting upward pressure on prices, and first homebuyers typically lack the capital to compete in bidding wars. First homebuyers are generally part of the younger generations, and a recent census has shown 25-34 year old homeowners have dropped from 62% to 45% in the last 30 years.

The above statistics all point to Australia being in the midst of a housing bubble, which ‘Investopedia’ defines as “a run up in housing prices fuelled by demand, speculation and exuberance”. Fortunately, a method has developed in the United States that is helping first homebuyers navigate an inflated housing market. This method has been coined the ‘mortgage-merry-go-round’, and involves first homebuyers building the required capital for their desired home from the refinanced payments of their parents homes. Once the new house is purchased, the child then refinances their new home to pay the parents back. The process eliminates the high-interest loans often given to younger buyers, and allows them to compete with experienced investors when bidding on properties.

A few requirements need to be met in order for the mortgage-merry-go-round to be successful for young Australian first homebuyers:

1). Obviously the parents must be in a stable financial position themselves, and their property must have adequate equity to fund the cost of the new loan.

2). The child must be able to cover the cost of the refinanced repayments on the parent’s house.

3). A single lender should be used throughout the entire process, and they should be made aware of the plan from the outset in order to provide the most accurate refinance rate estimates.

4). Although refinanced loans generally have lower interest rates, it should always be confirmed they’re cheaper than a traditional loan.

5). Managing this method requires a large amount of co-operation and transparency between all parties.

If the above requirements are met, the mortgage-merry-go-round could be an effective way for young Australians to successfully own their first home. It is not however a permanent solution to the housing crisis in Australia. A housing bubble can only be burst by one event: when the supply surpasses the demand. Until such a time when the bubble is burst, complex methods like the mortgage-merry-go-round are required for first homeowners to enter the market. Australia is in a housing crisis, and this crisis is showing no signs of a resolution. The only ones benefiting from the current housing market are those who have entered it, and as the old adage goes: if you can’t beat them, join them.