Some basic maths....an example.Assumptions.A typical Aussie...

Some basic maths....an example.



Assumptions.

A typical Aussie couple – John & Julie.

Their combined income is approx $65,000 pa (before tax)

On a before tax basis the couple earning $65,000 pa today will earn $95,000 in 2015. (assuming 3% pa wage growth)

On an after tax basis the couple are earning approx $40,000 today, and will earn approx $60,000 in 2015.

The couple buy a 4 bedroom home in the inner West of Sydney (plans to soon start a family) for $400,000.

Home loan rate of around 6% today rises to 12% by 2015.

The couple have a $50,000 deposit.



Calculation

Cost of servicing their home loan today: $350,000 x 0.06 = $21,000 pa. (this equals to 53% of their income after tax – a very high commitment)

How many thousands of dollar would this same couple have available to service debt in 2015 assuming an equal (53%) commitment of after tax income?

Let’s see…

Available funds to service home loan pa: $60,000 x 0.53 = approx $ 32,000.

What size home loan could they afford at 12% under these circumstances?

Answer: 32,000/.12 = approx $265,000.



Conclusion

Over a period of 12 years, as a result of rising interest rates, and moderate wage growth, John & Julie’s capacity to borrow has fallen by 25%. How can property prices appreciate in such an environment?

They can’t! … Increased interest rates at some time in the future will lead to increased pressure on existing borrowers, and to a decrease in the capacity of new home loan seekers to borrow a sum of money to support today’s property prices.



End result?

The end of the boom… and the beginning of the bust.

Future liquidity will be unable to support today’s prices.