This is a common question i am asked by parents who are keen to see that their children get the same (hopefully better!) opportunities in life that they had. It’s not one of my worries, and i’ll share with you the reasons why i consider home affordability to be one of the least concerns for my children’s future.
House prices are only going up!
No, they are not. House prices are a function of cost, supply and demand like any other widget. There may be special “warm and fuzzy” reasons why people tell you housing is different but they are emotional responses – not based on good old cold, hard logic. Perth is an island of calm in a stormy global ocean when it comes to house prices. Try to not be fooled by localised mythology.
Financial Planning and Houses
In fact, even here in sunny Perth, comfortably insulated by one of the biggest mining booms of our history and the influx of large numbers of high-income mining specialists, housing prices are not as concrete as they appear. Here in the office, we are regularly confronted by stories of people trying to sell houses who are then discovering that the prices they had in their heads are nowhere near the prices buyers are willing to pay. It’s even more alarming when those “prices in the head” are associated with the 2006 year, as the falls from that level can be very substantial – 30% is not unusual.
Compare this with the United States, where housing prices are back to where they were in 2002. Think about that for a moment. What was your house worth 10 years ago? If the price of your home were to fall back to that level, how would your mortgage look? How would you feel about your overall finances? Would your current mix of expenditure, loan repayments, assets and investments be comfortable?
I’d like to share a common problem that emerged out of the US housing crisis, and we’ll convert it to Perth prices.
Let’s consider a very non-Perth scenario
Let’s say you paid the median house price of $190,000 for a home in 2002. You had a 20% deposit and paid the purchase costs from savings, so you only borrowed $152,000. It was a standard 30 year mortgage, and you we’ll assume you paid an extra $200 a month on top of a 7% interest repayment rate for the first 5 years. Things were going well. You only owed $121,000 and your home was worth $475,000. You had started a family, so you invested in some home renovations to make space for a new family member. Being careful with money, you only spent $50,000 on the renovations, and your total debt was now only $171,000 – a fraction of the house value. You are keen to reduce the mortgage, so you start paying $400 a month over the basic repayment.
The GFC hits but you continue to pay the extra – you’ve kept your job, and you’re determined to bring that debt down.
Now we’ll come forward to today, converting our Perth scenario to the US scenario. Your home mortgage is down to around $132,000. The value of your home has plummeted back to its 2002 value – $190,000. If a person lost their job or was unable to pay the mortgage and had to sell the home at this stage, they are going to receive less than $60,000 from all that hard work and prudent planning. From this example, you can see how devastated homeowners in many parts of the USA are right now.
In our example, we’ve looked at an example where a person was prudent, and repaid as much as they could, as fast as they could. If the person in our example had only made minimum payments, their debt would be over $180,000 – leaving them with less than $10,000 after repaying the mortgage, and i’ve ignored selling costs!
The internet makes finding the horrific details of the US house price crash relatively easy but for those with little time, here’s a link to a recent CNN article that highlights that 10 year reduction in prices.
Will my children be able to afford a Perth Home?
It is not my intention in this post to be negative, and to paint a picture of doom and gloom. However, any consideration of future house prices moving ahead 10 or 20 years needs to include both the positive and the negative outcomes that are possible. We’ve also focussed so far on house prices – but the issue of your children being able to afford a home is much broader than that.
It’s not house prices that count, it’s your child’s ability to access capital at a rate that makes the purchase worthwhile.
Of course, it also counts as to which house in which suburb your child would like to own a home. Most house price discussion is centred around the “median” house price but that’s just because it’s difficult to reduce the multi-facetted quilt of suburbs into a single figure. Obviously, there will be suburbs that cost an awful lot more, and those which are far more affordable.
Which brings us to the old adage of how to decide which house to buy in which suburb. For this, we could turn to a well-known suburban property expert for advice…
Brett: Well, there it is. I know it’s the worst house, but it’s on the best street. It’s what you’re supposed to buy.
Kim: No, you’ve got it all wrong. You’re supposed to buy the best house on the worst street, ’cause then you can lord it over people.
Umm, maybe not… but you do have to love the twist on the suburban dogma that you buy the worst house on the best street that you can afford.
Will my children even want to buy a home?
Michael! How could you even suggest such a thing?!
This is a “change of paradigm” question. In Perth, such a suggestion is tantamount to heresay – most parents who bought their home have done well out of the purchase. By far the greater majority have made the bulk of their wealth from their home purchases, so suggesting that this may not continue to be the case sounds like a foolish statement indeed.
And yet paradigms do change, and the golden disclaimer statement that financial planners are required to add to any financial projection – “past results are no guarantee of future returns” – is blithely ignored in practically every discussion on homes and housing that occurs in Perth today.
Were Australia and/or Perth to enter a 10 year hiatus in housing prices (not an altogether unlikely event as we are already 5 years into a fairly flat growth period) then it is quite possible that your children will have a different view to the home purchase decision than yours of today.
To bring that into sharper focus, let’s spend a moment pondering the USA experience, to see what happens when financial and economic circumstances conspire to make fear of repossession a more important issue than ability to buy…
These are taken from a brief overview of foreclosures in the USA. The pdf can be found here.
The key points on home ownership
So it’s one thing to buy a home, and it can be another thing altogether to keep that home. The key points that you can take away from this review of “when things go wrong” are :
- The Perth “standard” of buying the most expensive house you can afford is a dangerous motto to follow across uncertain business cycles.
- Very few people will have the cash to buy their home outright. If there is a debt then that debt will add to the risk of the home purchase, leading to potential for the home to be lost. Steps should be taken to reduce those risks as much as possible.
- Having a pool of available funds to help in the event of unemployment. Sometimes it’s easy to jump from job to job – but more often it’s a case of 3 to 6 months of hard work, trawling the job adverts, attending a deflating series of interviews, and going through the uncertainty and worry about getting a regular income again. Access to 6 months income would go a long way to helping reduce that angst and worry.
- Health is fundamental. If your child is financially well-off then that’s great – they will be able to focus on their health and getting better should an illness or injury strike them down.
- Most children however, will not have yet built up their full financial strength. This is where insurance has a role to play, as most people simply do not have the resources to self-insure. Health insurance cover, income protection and “trauma event” cover are all ways of making sure money will be made available at the times it is most needed.
Young people tend to think insurance is a waste of time. They are going to live forever, partying and building their promising careers. Your job is to be the wet blanket, insisting that they face the realities of an uncertain world before they zip off to the next outdoor concert.
This may seem a dreary and negative way of considering home ownership. Surely it’s about choosing the suburb you want to live in, selecting an area they will want their children to grow up in, choosing a home style and format that reflects their personal dreams and inspirations? Maybe… but that’s your way of thinking, as a loving and caring parent. As a financial planner, my considerations for home purchases follow a very different pathway.
Will my children be able to afford to buy a home?
Let’s all hope that Australia’s political pond will spawn the kind of leadership that helps the country navigate what will be very tumultuous years in the coming decades. If it does then we can expect home ownership will remain a valid goal for the children of today.
Strangely enough, the worst thing that can happen from your child’s perspective, would be for Perth home prices to resume their pre-2007 growth rates. This would reduce home affordability by increasing the deposit required, the size of the mortgage needed, reduce the options of where they can live, and take a greater part of their earned income away from some of the things that make life worthwhile.
So, will your children be able to afford a home?
IF they have gained an education, with either a higher trade or tertiary qualification, and IF they develop a savings habit rather then a consumption habit, and IF they take steps to moderate the risks associated with what is likely to be the largest single purchase of their lives THEN the answer is “YES!”