The Trap Is Set

Nervous fingers are being pointed in every direction, looking to cast blame for soaring house prices.

A raft of experts cite factors for the price push, ranging from a shortage of metropolitan area land, to Government tax policy, where capital gains are effectively taxed at a maximum rate of 25 per cent (if held for more than a year) – and that’s after investors have slashed their tax bill from ordinary income as a result of negative gearing and other costs on the rented property.

Banks lending too freely and the combined borrowing power of two-income families have pushed average home mortgages close to the $500,000 mark.

To top it all off, double digit annual capital gains on property investment in the past few years have given people the impression that the property boom and its attendant capital gains will continue indefinitely.

But how this process relates to individual circumstances became a little clearer from the story of one reader. He wanted to buy a $550,000 second property as an investment, and went to his bank to see how much his repayments would increase by.

His Personal Banker was on the phone pronto. The PB noted that the reader already had a house with far more equity than he had last year, when the banker drove past his house and assessed its value.

As a result of his increased “wealth”, the PB had calculated that the reader could borrow, not $550,000, but – hey! – $680,000, leaving him a buffer to renovate the prospective purchase, add a new kitchen to his current house and roll his credit card debt into the housing loan.

There were a couple of catches, though.

The “new deal” would involve recasting the existing arrangement into a new loan, using both the existing and the prospective purchase as security. And the interest rate on the total loan would go up by about 2 per cent. Of course there would be some valuation and facility fees to add.

This bundling of the two loans did not suit the reader. He worked out pretty quickly that he didn’t need a loan larger than $550,000, so why should he pay a higher interest rate on the additional $130,000 pushed on him? He didn’t want to do renovations and he had only recently put in a new kitchen. Nor did he have a credit card problem. Nor did he want to use his home equity to escalate consumption spending.

The bottom line of the bank’s arithmetic for him was a increase in his monthly repayments from $2100 on the existing loan to $5700 on the recast facility – nearly three times the previous level.

As he was doing his sums, the news was full of forecasts of interest rate rises and property prices levelling or even falling. Tenants were harder to find.

But the real crunch came when he got wind that his company was merging with another and his job was likely to go.

How glad he was that he didn’t jump at the PB’s deal, and buy the second house, having to meet $5700 a month while trawling Sydney for a job.

The second house is still on the market.

The reader, although facing an uncertain job future, at least knows he can handle his existing debt comfortably from his wife’s income and his savings. His house is not on the line, as it would have been on the recast deal, if he had been forced to sell the second home at a loss.

Years ago life insurance companies were criticised for bundling their savings and death cover policies into one whole of life policy, making it impossible to work out how much the policyholder was paying for death cover and how much was left over for investment, and what that investment was returning. It was also impossible to work out how much in fees and commissions went to the life insurance company and their salespeople.

Consumers woke up to this and demanded separate products where they could shop comparatively. Old-style life insurance policies, which did not break even for more than 10 years, died on the vine.

Now banks have stepped into the breach, bundling existing housing loans with new investment housing loans, credit card debt and personal loans and rolling them into one, making it hard to work out just what you are paying for each individual product.

It is offers from banks of huge loans that are also largely responsible for the blow-out in housing debt that has the Reserve Bank so worried. That PB probably thought he was doing the right thing, but he was no doubt also hoping to meet lending targets set by the bank, delivering it more interest and fee income, as well as providing the bank with more security.

We’re all bunnies if we fall for it.

[satan]

We are all made from Stars