The average mortgage for owner occupied homes has ticked over $520,000 and climbing. Record low interest rates are certainly attractive to anyone taking on a large mortgage to buy their first home. Rates of around 2%–3% mean lower repayments and greater initial affordability. But significant financial risks should not be ignored.
Interest rates fell dramatically to address the global financial crisis over ten years ago, and then again as governments and central banks responded to the dire economic conditions of the global pandemic. Money printing has been unrelenting, but with signs of increasing inflation that printing is being scaled back.
Increasing demand can mean higher inflation which generally suggests interest rates will increase. The Reserve Bank has indicated they will remain low for another two to three years, but has been wrong before, so we shall see.
That’s probably good news for borrowers in the short term, but home mortgages tend to be contracted for 25–30 years and a lot of economic change can occur. So think carefully about the steps you can take to address financial risks.
Maximise your deposit to increase your initial equity in your home. This not only reduces the size of the loan but can also ensure you avoid costly lender’s mortgage insurance.
Lending institutions usually apply a ‘stress test’ to initial applications. One of the big four banks considers your ability to service your mortgage if interest rates climb to 5.25%. The highest rate reached in the last 20 years was 9.6% in August 2008.
You might apply your own stress test and consider factors such as employment changes, starting a family and illness that might impact adversely on your ability to maintain repayments. Carefully assess associated costs like stamp duty, council rates, home and contents insurance and utility costs.
Consider taking income protection and death and disability insurance cover. These can often be arranged through your super fund and are often a lot cheaper than you realise.
Finally, some borrowers with low deposits are turning to the bank of mum and dad for assistance. If family members are helping with a cash injection to increase a low deposit, that can work well. There is a much less satisfactory option available. It is apparently becoming more common, as housing prices and deposits spiral upwards, for parents, or another third party, to take on the responsibility of mortgage guarantors, using their own homes as security. If you default on mortgage repayments, their home could be at risk. This should be a last resort and preferably avoided.
Don’t let the fear of missing out cloud your thinking. Be realistic in assessing your financial situation and measure the risks carefully.
Note: This article is in no way intended to provide you with personal advice and you should discuss your own circumstances with your authorised financial adviser before committing to any decisions on matters raised in the article.