Big mortgages squeeze home buyers' basic living costs
Australian Financial Review May 22 2017 11:00 PM
Sally Patten
Borrowing six times a household's salary to buy a property would make it difficult for many people to cover even basic living costs, says financial adviser Adele Martin of Firefly Wealth.
Ms Martin said that borrowing such a large multiple of income could trigger a debt spiral as homeowners turned to credit cards to pay for both unexpected and everyday living expenses. The problem would be exacerbated by a rise in interest rates, she said.
"At six times salary, with any rise in interest rates, any unexpected expenses, like a vet bill, are going to cause trouble. It could get people into a credit card debt cycle that is hard to get out of," Ms Martin said.
She was speaking after a report by investment fund JCP Investment Partners found that the average loan-to-income ratio of heavily indebted households was 6.4, more than double the old banking "rule of thumb" that mortgage managers didn't lend more than three times a household's income.
Adelaide-based adviser Mark Draper of GEM Capital said borrowing at six times an individual's salary was "pretty toppy" and said that in the case of property investors, too many people were taking on extra debt without thinking of the risks. He argued that after more than 25 years of continuous economic growth, too many people viewed the housing market as a "one way bet".
He, like other advisers, urged borrowers to consider whether they could continue to service their mortgage debt if interest rates rose by 2 percentage points before taking out a loan. Many advisers recommend that households spend a maximum of 30 per cent to 35 per cent of their net income on mortgage repayments.
"If more than 30 per cent of your net wage is going to repayments, that's when people can start to struggle. You are not giving yourself any wiggle room," Ms Martin said.
Dominique Bergel-Grant, founder of Leapfrog Financial, agreed that 30 per cent of a person's salary was about the right amount to spend on mortgage repayments.
If a couple earning a combined $160,000 took out a $960,000 loan, which would be equal to six times their salary, assuming a 4.5 per cent mortgage rate over 25 years, the loan repayments would be 53 per cent of their take home pay, Ms Martin calculated.
She said in many cases, people were already were putting living expenses and extra expenses on their credit cards because of high mortgage repayments and stagnant wage growth. In some instances, people were cancelling private health insurance to reduce financial stress. "One in five Australians can't come up with $1000 to meet an emergency payment," she noted.
Suzanne Haddan of BFG Financial Services recommended clients assume that mortgage rates could climb to more than 7 per cent when deciding if they could afford to service a home loan.
"We use a 7.25 per cent interest rate to ascertain affordability," Ms Haddan said.