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What’s relevant for you in the HGS and Australia’s property bubble?

16 May 2022


Recent big changes to the Home Guarantee Scheme (HGS) mean you can buy a more expensive house with only 5% deposit, but even if you’re not intending to do this, it’s worth being aware of what amendments to the Scheme could mean to your situation in Australia’s property bubble. They could have significant influences on it, both pros and cons.

Depending on where they live, people can now spend between $450,000 and $900,000 on a new house under the Scheme.

However, inherent in this are risks that could burst the property bubble and trigger national angst.

Consider first the HGS’s pros

The HGS will encourage house building in regions across the nation – many of them in more need of more new houses than at any time in their history.

But wherever you want to build a house, cost has been rising rapidly and the updated HGS helps cover that.  (For example, the price of timber alone has tripled since the pandemic started.)

By increasing borrowing capacity for new home buyers, the Scheme now gives builders more confidence they can sell houses, recently completed or under construction – which is a major boost for an industry that has had a particularly hard time of it during the past two years.

Since last year house prices have been rising so fast many potential buyers have seen their deposit shrink as a percentage of a house they’d like to buy, to such an extent that purchase became impossible. Now it could be possible.

Someone wanting to buy a $500,000 house who had saved $100,000 as a 20% deposit, having seen the property’s value increase in less than 12 months to $600,000, would need to find an extra $20,000 for a required 20% deposit. Thus, an impossibility without the HGS could become a possibility within it.

The new HGS could not only help make such a purchase possible, but also ensure the purchaser doesn’t have to spend thousands of dollars on Lender’s Mortgage Insurance.

Now consider cons of the HGS

Some of the apparent pros of the HGS could be cons, encouraging financially vulnerable people to spend more on a house than they can afford in challenging times, certain soon to become more challenging as inflation and interest rates rise.

But so far, so good.  Macks Advisory is unaware of any defaulters under the HGS, and millions of Australians have been able to make the most of low interest rates, not only to maintain positive equity in their homes, but to increase it.

According to Assistant Treasurer and Minister for Housing Michael Sukkar 41.8% of Scheme-backed loans are in advance of their scheduled repayments, 58.2% are on schedule, and he confirms the Scheme “has not experienced any defaults to date”.

Currently almost every home loan borrower in Australia is in positive equity – “above water with their loans”, as bankers say.  There are 99.75% home buyers now with above water loans compared to 97.5% at the start of the pandemic.

Borrowers are paying off their mortgages faster now, and thousands of people who before then had no hope of buying a house, are today living in a home they’ve been able to finance with a deposit as low as 5%.

Chances are, if you borrowed $420,000 to buy a house worth $500,000 last year, it could well be worth $550,000 now, in which case you’d be well “above water”.

So, what could possibly be wrong with this picture?

Look at the overwhelming number of people the HGS is encouraging into the real estate market.  Most are would-be homebuyers with the smallest deposits, they are the most vulnerable of borrowers should the market decline.

And this is exactly what is predicted.

So, let this be all about you

Are you living in your own house?  Suppose you’ve bought a $600,000 house with a $30,000 (5%) deposit, that you have a $570,000 mortgage, and a few months after you’ve signed for it, the market drops 10%.  You’ll owe probably close to $570,000 on a house worth $540,000. Oops!

This month the Reserve Bank of Australia (RBA), for the first time in 11 years increased the cash rate.  The rise from the prevailing record low rate of 0.1% to 0.35% was more that most finance experts expected, and the Bank has warned of forthcoming “falls in housing prices”.

Indeed, it has estimated these could drop as much as 15% over the next couple of years.  In a recently issued statement the RBA said, “it’s important lenders and borrowers consider [in the context of rising interest rates] the potential for falls in housing prices”.

Let‘s talk about loan-to-value ratios (LVRs).  If, as in the case above, you own a house with a value of less than the bank loan on it, your banker would refer to that as an underwater loan, because the LVR would be more than 1. If the value of your house is greater than a loan you have on it, bankers would refer to that as an above water loan because the LVR would be less than one.

If you bought your house with a 5% deposit and a loan on 95% of its value, and the value drops 6%, you’re suddenly the owner of a house with a more-than-one LVR – and the Commonwealth Bank has predicted an 8% drop in house prices in the immediate future.

Maybe the newly constituted HGS may to some extent delay this by propping up house prices, but then again, maybe not. Let’s just hope you have heeded the RBA’s warning and haven’t saddled yourself with a mortgage you can’t afford.

We are not scare mongering here. Rather are we encouraging readers to come to grips with reality including fresh warnings about the housing market that appear in a recently published review of the Australian financial system’s stability -- where page after page of statistics and analysis reveal why the RBA worries that so many people are borrowing so much, they’ll be unable to cope with rate rises.

We understand the RBA’s prediction on house prices comes from a model based on a cash rate rise of two percentage points, which shows that over two years house prices will drop 15%.

You need to bear in mind relative to your financial situation that the more interest rates rise, the fewer will be the number of people who will be able to afford to pay for a house, and this will force down house prices and create a situation where lenders will be ever more inquisitive in efforts to determine whether borrowers can afford to repay and/or refinance their loans.

The new cash rate of 0.35% means people with a $500,000 mortgage will now be paying $68 more a month on repayments, $168 extra month on a $1m mortgage – perhaps not too much of a concern. But if the official interest rate rises to 2.5% as the RBA expects it will by the end of next year, then about $200,000 in extra interest charges will be added to standard $500,000 mortgage, and monthly repayments will be $575 more than they are now. This would not be a happy situation if you had such a mortgage on a house worth about 15% less than it is now.  

When Americans decide they can’t repay a house loan they hand the keys to the bank and move on. However, Australians traditionally are inclined to do everything possible to repay a house loan even when they owe more than the house is worth -- and this can only be good for the stability of the nation’s financial system.

So, maybe the new HGS won’t burst the Oz property bubble. We can only hope it doesn’t, even when there are strong indications that it could.    


Disclaimer: The information contained in this webpage is general information and does not constitute legal advice. Nothing in this webpage is or purports to be advice. If you do need advice, then you ought to seek and obtain appropriate personal professional advice based on your personal circumstance.

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