When you look to buy residential real estate, there is a rational temptation to stretch for the best property you can buy: value for money. As you move up the price ladder, the competition thins out, the buyers become more discerning and you start to get more value for your money. For that extra $100-200K it can sometimes seem like you get twice the house. And the further up in price you move, the more pronounced the effect seems to become.
This is a cautionary tale about the price you might pay in the years ahead, even if you can afford it today.
Excessive debt is a hidden evil in today’s society. You seldom hear about the thousands of home owners whose lives are ruined by jumbo sized mortgages. Here are five gotchas for your future that you should consider before committing to a level of debt beyond what you can comfortably afford:
1. Over-estimating your comfort with debt
Firstly, it’s very easy to make an emotional buying decision, especially when you are looking for a new home. You find a house you love, and buy the house you want rather than the one you need. It’s particularly seductive as a young couple to think “she’ll be right” when you are both earning a good income and can afford the higher repayments – for now. But over time, the unseen burden of this large financial obligation can start to eat away at you and leave you with gnawing feelings of insecurity.
2. Not anticipating the impact on your lifestyle
Borrowing as much as you can will leave you with little or no spare cash for the occasional night out as a couple, let alone an overseas holiday.
3. Assuming your work situation will persist
Sure, your job’s great now: Pays well? Tick! Like the people you work with? Tick. Enjoy the work? Tick! But things change, people move on, companies downsize. What if your boss leaves and instead of a promotion they bring in someone externally who turns out to be a total jerk and makes your life a misery? You’ve been there for a while and moved through the ranks into a senior position and you’re well paid. But when you take a look at the job market it’s pretty barren. The few opportunities you’ve found are at materially lower salaries. You do the sums and are alarmed to find you couldn’t make your mortgage repayments on those wages. You’re trapped.
4. Not looking ahead to where you want to take your career in the next 5 years
Is a career change on the horizon? Thinking about taking the plunge to follow your passion and start a new business? Both of those options are exciting and incredibly challenging in their own right. Jumbo-sized mortgage obligations might make them just about impossible. If a move like this is on the cards for you, please think very carefully before over-committing on a mortgage – the opportunity costs can be substantial.
5. Assume real estate investment is a magic pudding that always goes up
Fundamentally, real estate prices are driven by what people can afford to pay. What people can afford to pay is determined by two things: disposable income and interest rates.
Over the last two decades both of these factors have had strong tailwinds behind them driving real estate prices higher:
- the move from single-income to double-income households, and
- de-regulation of the banking sector and the subsequent competition driving down the cost of borrowing, reinforced by falling interest rates.
These two factors have been primarily responsible for bringing prices to their current peak. However, neither factor has anywhere left to go. Unless a polygamy craze sweeps the country, we can’t move from a double-income to triple-income household. The banking sector can’t be deregulated twice and interest rates move in generation long cycles, and at a record-low rate of 2.50% we’re at the bottom of one or very close to it.
House prices are on the move again, but be cautious and look at the bigger picture – as human beings we have a natural tendency to extrapolate into the future based on the recent past. Australia has enjoyed unprecedented and uninterrupted growth over the last two decades, but the historical tailwinds behind house prices are changing course.
