For many of us, buying or investing in a property will be one of the largest purchases we are ever likely to make. However in order to do so, the majority of us will require a loan from a bank or a lender in order to afford this purchase.
With property prices already sky high across the country, we seem to be borrowing even more than ever before. The average household debt in Australia is now three times more than 25 years ago with more and more people living beyond their means, according to the Bankwest Curtin Economics Centre study.
The average mortgage debt has almost tripled in 25 years
The average mortgage debt as a proportion of property values has almost tripled over the past 25 years, rising from 10 to 28 per cent since 1990. Back in 1990, the average household debt represented less than six months of annual income, whilst today this has tripled to 18 months of annual income.
It is therefore important that we as buyers do not take on too much debt to put us in financial risk and difficulty which could result in bankruptcy.
Borrowers now taking on too large a loan
Banks have reduced their investor lending since last year where investors now need a 20% deposit when purchasing a property and can only borrow 80% of the purchase price, or even less. However, first home buyers are still able to get a loan for 95% of the property purchase price, but in some cases are borrowing far more than they could afford to pay back and are now facing bankruptcy.
Although the borrower is partially to blame for taking on too large a loan in the first place, the banks are also responsible by not providing a duty of care to their clients. They should be noting how high the risk is to the buyer and what this could mean in financial terms.
In particular, banks in more regional locations are irresponsibly loaning large amounts of money to people who are unable to pay it back, due to a collapse in the property market. This is common in remote communities in Queensland, Western Australia and the Northern Territory. In this situation, the banks are urging buyers to take on extreme levels of debt to own a property, but are not taking the time to advise them of the consequences of their actions if the property market was to collapse.
Thousands of investors face bankruptcy
One example that has come to light is an ordinary income earner, aged 24 years old who was loaned a massive $6.5 million by a bank and encouraged to invest in a “highly volatile” market in Moranbah, a small mining town in Queensland. She ended up buying 10 properties.
However what she didn’t know was that the bank knew that there was a medium to high risk to the values collapsing, leaving these homes abandoned by potential renters.
It’s not just one isolated case though; there are thousands of investors around Australia that could now be facing bankruptcy due to the rationality of lending practices and not being able to find rental tenants for their investment property. This particularly affects investors who bought their properties during the peak of the market. They might have bought a property valued at $600,000, but today their values have plummeted to just $100,000 – a huge loss.
Regional Areas vs CBD
Buying an investment property in a regional area like a mining town is risky business. This type of market offers uncertainty, and whilst you might be rolling in it when the market is booming, when the market slows down and mines start to close down then this is when you will suffer. This type of area relies solely on the mining industry and without it; there will be difficulty to tenant your property, when people start to move away from the area.
The same applies for tourism. If tourism dries up then you are left with a property that will be difficult to rent out.
Instead you should be buying a property that is not reliant on seasonal or mining industries. You should focus on buying a property that is close to key amenities including transport, shops and schools and close to the CBD and employment hubs. This provides people with convenience as they prefer to live close to their workplace or within walking distance of public transport and shops.
Today, investors looking to purchase an investment property will have to borrow 10 to 20 times their gross income which is an absurd amount of lending. Property is simply overvalued in some parts of the country.
If property prices do fall dramatically, then investors will be left with extremely high loans to pay back with no or little returns from their investments, forcing them to sell and have a large level of debt over their head, or worst case scenario, become bankrupt.
Buyers should therefore take a step back and firstly examine their borrowing capacity and what they can actually afford which does not put a strain on their finances. If interest rates take a surprise hike then will you be able to still afford your mortgage repayments? If buying property off the plan, then interest rates might currently be low, but that doesn’t mean they will still be low by the time your property settles in two years time. You should always prepare for the worst case scenario and have funds easily available that you can tap into if required.
Banks shouldn’t be loaning large sums of money to borrowers who are purchasing investments with a high level of risk associated to them. It doesn’t do any favours for the bank and can be damaging for the borrower.
So what should you do to avoid bankruptcy?
- Purchase an investment that is well within budget to avoid financial pressure.
- Purchase a property away from regional areas that rely on seasonal or mining industries. Try to look for high growth suburbs that will provide good cash flow and capital growth.
- Budget for interest rate rises and choose a fixed loan.
- Research your banks and lenders and shop around first for the best loan package to suit you.
- Talk to an expert property consultant like iBuyNew who can guide you through the property purchasing process as well as a reputable mortgage broker to assess your borrowing capacity.
Published on 24th of February 2016 by Marty Stanowich