In the May newsletter, we started looking at the options available for would be first home buyers trying get into the market in the face of rising property prices and generally without a large deposit.

I outlined 4 solutions:

1. Borrow up to 95% of the purchase price (if you can get one)

2. A gift of money from family

3. Other forms of family assistance (Security guarantee &/or Income guarantee)

4. Down grade your expectations (the unpopular option)

Options 1 & 4 were dealt with in that article and now I turn to look at options 2 & 3.

A gift of money

Many first home buyers have sufficient income to show they can afford a loan that would more than cover what they need to borrow to buy the property they want. However, given that banks will only lend up to 90-95% of the value of the property being bought, first home buyers often face a gap between what they have (savings +first home owners grant + bank loan) and what they need (purchase price + stamp duty + associated costs).

A gift of money from family can close this gap. The gift must be unconditional and non-repayable. Getting a gift has no adverse impact on a bank’s assessment of the overall application.

Other forms of family assistance

Security Guarantee

A number of lenders will allow guarantees from a related party such as family. The most common type of guarantee is where a family member offers a property they own as a second security for some part or all of the borrowings.

A Security Guarantee helps in a couple of ways. Firstly, it usually helps the borrower to avoid Lenders Mortgage Insurance as the loan amount being sought is less than 80% of the combined property values mortgaged to the bank. This can mean a saving of anywhere up to $20,000 in costs.

Secondly, it can remove the need for a purchaser to contribute its’ own funds. If a purchaser can demonstrate that it can afford the amount it wishes to borrow, it does not matter that they have no savings or that the loan is for more than 100% of the value of the property being bought. The key is that the loan being sought must be less than 80% of the total value of the properties being used as security.

A Security Guarantee is a fantastic option for a purchaser that has family keen to help them to purchase a property but are not in a position to give a gift of money and where the family own a property outright (i.e. no mortgage) or at least have significant equity in property they own.

However, it is important for would be guarantors to understand the legal obligations they are taking on with the guarantee. If the purchaser does not make their loan repayments, the bank will look to the guarantor to take over any debts it has guaranteed, failing which the bank will look to sell the security properties to satisfy the debt.

Correct structuring of the lending will help protect the guarantors and minimise their potential liability.  The ideal is to set up the lending as two loans:

Loan 1:  80% of the value of property being purchased in the names of borrower(s) alone.

Loan 2:  Remaining loan amount sought secured against the guarantor(s) property with the purchaser as borrower and with a guarantee from the guarantor.

This means the guarantor’s exposure is limited to the second loan and not the total lending.  The guarantee can be released at a later stage and does not need to endure till the end of the loan. At the time that the borrowers seek to remove the guarantee, they need to “qualify” for a loan on their own footing with the bank. At that time, if the lending amounts to more than 80% of the property value then the mortgage insurance will be payable.

Income Guarantee

Another type of guarantee that can be handy is in the opposite situation. A purchaser has a good deposit/savings but does not have sufficient income to afford the loan they need to complete the purchase.

In this situation most lenders will not be able to lend to a purchaser. However, at least one lender will be able to help if there is someone who can go guarantor, whose financial position is such that the bank can see that the purchaser can afford the loan when the guarantors’ financial position is also taken into account.

The purchaser needs to be able to demonstrate that they can substantially afford the loan on their own and that the guarantor’s income is only secondary support.

Conclusion

With house prices rising and banks getting tougher in their assessment of loan applications, the dream of home ownership is getting to the point that it is beyond the reach of many first home buyers without some assistance from family. Hopefully the 4 strategies outlined in this article and its predecessor will give you some ideas on how to bring home ownership back within the grasp of yourself or someone you know.

Yesterday i posted REIV stats showing that median house prices in Melbourne continue to increase at a solid rate…hot on the heels of the REIV report came an interesting article in the Herald Sun (August 10, 2010), showing that prices of property in the $1M+ price range have fallen by 15% from their peak.  The Herald Sun reported:

Melbourne homes at rich end of the market slump after years of growth

WEALTHY home owners have been hit by a 15 per cent drop in the value of their homes.

A bidding slump has seen more than $200,000 wiped off the average price paid for homes worth more than $1 million.

Property valuation company Herron Todd White said that after rising almost 70 per cent in the past six years, the prestige housing sector median has fallen from $1,593,500 in the March quarter to a current median of $1,363,500.

The worst hit suburbs include Toorak, South Yarra, Middle Park, Malvern, Brighton, Canterbury, Armadale, Kew and Albert Park.

Herron Todd’s national research director, Richard Jenkins, said the price of more affordable homes had remained steady or risen.

“Melbourne’s housing and unit markets have continued to record solid increases with the housing median rising from $524,500 to $559,000, while the median price for a unit grew from $450,000 to $463,000,” he said.

“Over the past six years, Melbourne’s prestige residential market outperformed both apartment and housing, growing by 68 per cent compared to apartments, which enjoyed growth of 54 per cent and housing, which grew by 53 per cent.”

Buyers advocate David Morrell, of Morrell and Koren, said the tide had moved in favour of buyers and vendors were being forced to lower their expectations.

“Agents are now spruiking a flood of properties about to come on to the market; but even if that’s true, there are too few buyers around to soak up any tsunami,” he said.

He said expectations that a house in Moorakyne Ave, Malvern, would sell for more than $4.5 million were dashed when three bidders stopped at $4 million - $5000 less than the home brought in 2007.

He said another home in St Georges Rd, Toorak, passed in on a vendor bid of $2.5 million against a reserve of $2.9 million on Saturday.

A Hawthorn home for sale for more than $4.5 million last year passed in on a vendor bid of $3.6 million.

“The tightening of foreign investment laws preventing buyers from buying existing residential property, unless as a main residence, has no doubt had an effect on overall prestige price rises and this is likely to continue to effect this sector,” Mr Jenkins said.

REIV CEO Enzo Raimondo said that as the auction market has returned to a more balanced position, price growth is being driven by demand in the city’s more affordable suburbs.

“The strong June quarter reflected the state’s increasing population and wider positive economic factors and has resulted in higher housing prices in the middle of the market.

“Increased housing prices, rents and interest rates are contributing to worsening affordability in Melbourne.

“Dandenong, which now has a median house price of $500,000, recorded the highest increase – 31.5 per cent – followed by Rosebud, whose median is $413,000 after an increase of 18 per cent.

“Broadmeadows, Footscray and Glenroy also recorded strong increases in demand and their median prices.

“Analysis of sales by method shows that the median price of a house sold by private sale increased by five per cent and the median of a house sold by auction reduced by two per cent. This is in part due to an increased preference for auctions as a sales method in the first half of this year.

“The increased demand and prices in suburbs not dominated by auction sales also reflects the fact that during the quarter the auction clearance rate dropped from 85 per cent to 74 per cent.

“Prices have also continued to rise in the unit and apartment market, with an increase of 4.7 per cent to $463,215 in the quarter. Carlton, Ascot Vale, Malvern East, Northcote and Footscray had the largest increases in their medians over the quarter,” Mr Raimondo concluded.

For a copy of the suburb by suburb listing of median house price changes email us at tim@hatchfs.com.

Interestingly, over the past five years both classes have recorded near identical increases in their medians, with the median for a house increasing by 55.3 per cent compared to 54.4 per cent for a unit or apartment.

The suburb of Carlton recorded the highest increase, 77.5 per cent in the quarter; however; due to a very wide disparity in the stock – from inexpensive student accommodation to highly expensive apartments – the median in Carlton does vary considerably based on the actual homes sold that quarter. In the June quarter it was $410,000.

The second-highest growth was recorded in Ascot Vale, where the median increased by 44.4 per cent from $427,500 to $617,500.

Third on the list was Malvern East, where the median increased by 27.3 per cent from $495,000 to $630,000.

Rounding out the list of the top 10 suburbs ranked by the change in their median were other inner-city suburbs: Northcote, Footscray, Hawthorn East and East Melbourne.

This highlights that the highest demand in this class of housing is in the inner city, where the high cost of land makes medium- and higher-density housing the only way many buyers can afford to live close to the CBD.

For a copy of the complete REIV list suburb by suburb, email me at tim@hatchfs.com.

It has never been harder for first home buyers to get into the market. Australian property prices are at record highs and each week they go up further.

With property prices having gone up by between 20% in the last 12 months even the most diligent savings efforts by 2 young professionals (each on 6 figure salaries whilst living at home rent free) would not have made buying a home easy.

These challenges have been exacerbated with lenders tightening their lending criteria over this same period. Here are some of the changes to the lending landscape with major institutions:

1.  100% home loans no longer available

2.  3 out 4 of the “big banks” only offer 95% home loans for existing clients and only then for applications with no “blemishes”

3.  The new norm is a maximum borrowing of 90%. Leaving customers to cover the last 10% plus costs (15% of the purchase price in total)

4.  Lending criteria have significantly tightened for mortgage insured deals, for example:

* Genuine savings equal to 5% of the purchase price is now required with most lenders
* High credit card limits are viewed negatively even if you pay off the debt each month
* Lenders are less willing to count commission or bonus income (or will only include a portion of it based on 2 years evidence of the income)
* One lender requires applicants to have a minimum of 12 months employment in their current job
* All lenders are demanding greater documentary evidence of assets/liabilities/income shown in applications

So it seems to me that even if we do get a property correction in Australia in the next decade the challenge for first home-buyers getting into the market remains.

The question is, in the absence of a large cash deposit, how do you get into the market? Really there are 4 ways to go about it.

1.  Borrow up to 95% of the purchase price (if you can get one)
2.  A gift of money from family
3.  Other forms of family assistance (e.g Security &/or income guarantees)
4.  Down grade your expectations (the unpopular option)

I am going to look at options 1 & 4 now and will look at options 2 & 3 in the next newsletter.

Borrowing up to 95%

Firstly, lets clarify one thing. When we talk about borrowing 95% we are talking about borrowing 95% of the price you pay for the property, and not the total cost (purchase price and stamp duty etc). That is the standard industry way of referring to borrowing percentages.

Now on with the “How To”…Whilst 95% home loans still exist, to be successful in getting one, applicants need to do everything right and even the smallest blemishes can be terminal to an application.

So the key is to set yourself up for success and when you do apply for the loan, be thorough in providing the bank with everything it will need (and this is where your broker needs to take charge and lead you through the process).

Here is a 7 step checklist to follow if you are looking for a 95% home loan:

1.  Simplify your banking in a few easy steps:

• Set up one central savings account and accumulate/hold your savings there. Running 3-5 accounts is messy and may cause confusion for the bank when it is assessing your application. You want to be able to simply and clearly demonstrate savings
• Reduce your credit card limits. Ideally keep total card limits under $10,000. Less is even better.

2.  Check your credit record now. It will almost certainly need to be totally clean. If there is a default, deal with it. Get it paid off or removed. Unless it is for an amount less than $200 you will need the best explanation to still be able to get a 95% home loan. Credit inquiries are not an issue but all inquiries in the last 2 years need to be explained.

3.  Maintain a perfect payment record on all credit cards and personal loans. Don’t miss payments. Keep credit cards under the card limits and make at least the minimum payment each month even if you are under the card limit.

4.  Accumulate 5% genuine savings – This involves being able to show that you have held or saved an amount equal to 5% of the purchase price in the last 3-6 months. Note that I said “saved or held”. You don’t have to save the full amount in that time. It is sufficient if you have held that amount in your account during that time. If your family gift you an amount now, then in 3 months time it is deemed to be genuine savings as long as you have not spent it.

5.  Stable employment is regarded highly. As a rule of thumb banks want to see 12 months in current role or 2 years in same industry. If you are in the middle of a probationary period for your job, you will likely have to wait till it has finished.

6.  If you have good salaries but relatively low savings, be able to demonstrate where your money has gone. Ideally, this will be in acquiring other tangible assets (car, home contents) or income generating assets like shares.

7.  To qualify with individual lenders this is what you will need:

• ANZ - Do not currently offer a 95% home loan for first home buyers. Time to move elsewhere. Try CBA, St George or Westpac.
• CBA - Take out a CBA credit card and hold it for 6 months.
• NAB – will do 95% loans for customers and not customers but the application needs to tick all the boxes above and more AND have no negative aspects. They make it hard to get a loan at 95%.
• St George – you need an active St George account (any) that has been open for at least 6 months
• Westpac – Be an existing Westpac client (any type of Westpac account) and pass the bank’s credit score. Credit scoring is a highly “mystical” process that the bank does not explain. It is basically a mathematical assessment of your application. If it “scores” high enough you pass. But the bank cant/ wont tell anyone how you go about doing that.
• Other lenders - There are some smaller lenders offering 95% home loans that may consider scenarios that the big banks will not. One example is Bankwest. But expect to pay slightly higher rates

Down grade expectations

When it comes to buying a home, mostly we know what we want. We know what suburb it will be in, how many bedrooms/bathrooms, whether it will have a garden, garage, renovated etc. This is not the tricky part of buying a home…the hard part is being able to afford what we want.

Sometime, we just have to admit that what we want may be beyond our financial means and that certain things on our “shopping list” are not really that “essential”.

Be prepared to make the hard call…concede that suburb X is out of your price range…that an apartment is more realistic than a house…that living 10 mins further out will be OK.

Twenty years ago, Bentleigh was an unfashionable suburb, old and tired and “too far out”. This was even though it was only 5 mins down the road from Caulfield and Elsternwick. Now it is young and vibrant. Full of young families and fantastically renovated Californian bungalow style houses. It is also no longer cheap and families wish they could afford to buy there but instead are looking 5 mins further down the road…

Finding ways to keep the price of the property you buy down may allow you to get into the market now and help you get further ahead in the long term. Property as an investment is not just about seeing the price of the property go up. It is about paying off the debt as quickly as possible.

So be prepared to ask the hard questions as you set out to buy your home. The answers you come up with may just reward you handsomely.

“Recently, forecasts for world GDP growth have been revised up again, and growth is expected to be at trend pace or a little above in 2010. Conditions in Europe remain quite weak, though recent data suggest growth is becoming more established in North America. In Asia, where financial sectors are not impaired, growth has continued to be strong, contributing to pressure on prices for raw materials. The authorities in several countries outside the major industrial economies have now started to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago, but sovereign risk concerns have escalated significantly in Europe over recent weeks. This has prompted additional efforts by policymakers to put fiscal policies onto a sounder footing and to provide support for Greece in the near term. To date, there has been very little contagion outside Europe.

Australia’s terms of trade are rising by more than earlier expected, and this year will probably regain the peak seen in 2008. This will add to incomes and foster a build-up in investment in the resources sector. Under these conditions, output growth over the year ahead is likely to exceed that seen last year, even though the effects of earlier expansionary policy measures will be diminishing. The process of business sector deleveraging is moderating, with business credit stabilising and indications that lenders are starting to become more willing to lend to some borrowers, though credit conditions for some sectors remain difficult. Credit outstanding for housing has been expanding at a solid pace. New loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off. Nonetheless, at this point the market for established dwellings is still characterised by considerable buoyancy, with prices continuing to increase over recent months.

Recent data on inflation confirm that it has declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. In both underlying and CPI terms, inflation over the most recent 12 months was around 3 per cent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year.

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago.

The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2–3 per cent over time.”

APM’s economist Matthew Bell said national median house prices growth slowed as five interest rate rises and the expiry of the First Home Owner Boost began to impact prices – rising a modest 3.1% in the March quarter to $542,827.

In the three months to March, all capital cities except Adelaide and Darwin saw the rate of growth of the median house price fall in March 2010 compared to December 2009.

Over the 12 months period, national median house prices showed a significant annual rate of growth of 16.2% driven by Australia’s strongest property markets in Melbourne and Sydney.

Sydney’s median house price is 14.7% above a year ago at $609,353, the highest level of annual growth since the end of the last boom in early 2004. Melbourne prices increased by a massive 27% over the last year to $549,980 - the highest recorded growth since 1995 – and units by 14%.

Brisbane’s market was flat after three consecutive quarters of growth. Prices fell -0.1% in the March quarter, the only capital city with quarterly growth under 1%. Unit prices also fell -2.2%. In Perth, prices were slighter higher +1.1% in the quarter, down from +3.1% in December quarter. Annual growth was 9.4% which was well under national average of 16.2%.

Canberra median prices for houses and units rise by over 13% during the year to March 2010. Although there was slight pause in unit price growth, Canberra recorded the second highest annual growth rate in the country. In Hobart, median house prices increased by 3.4% for the March quarter and 14.2% for the year and Darwin median house prices rose by 4.9% in the quarter, largely matching the December quarter rate of growth of 4.3%.

Adelaide was the only major capital to increase quarterly rate of growth in house prices from December quarter by 3.6%, up from +1.5% in December.

Meanwhile Bell said price growth for houses in the most expensive half of the market was nearly double that of the more affordable sector.

“The strong performance has been driven by the more expensive end of the market, being less sensitive to interest rate rises and the removal of first homebuyer stimulus.

“This top-end price growth has now moved well beyond a recovery of the price falls that occurred in late 2007 and throughout 2008 and is breaking new ground for most regions,” he added.

Bell said whilst growth in many markets around Australia remains positive but he warns that rising interest rates and falling housing finance figures will have a greater impact as the year progresses.

“Despite this quarter’s incredible levels of growth in the bigger markets, housing finance has fallen, and historically, price growth tends to follow this after six to nine months.

“This means that if past trends hold, house price rises should moderate further in the coming quarters,” he continued.

“However, we predict that the medium-to-long-term outlook for property prices remains strong, as demand continues to outstrip supply. After some slowing of price growth over the forthcoming months, we still expect the 2010 annual rate of national house price growth to settle in the eight to 10% range,” Bell concluded.

All other banks are expected to follow with their announcements in the next few days and I expect all banks to lift their rates.

At its meeting today, the Board decided to raise the cash rate by 25 basis points to 4.0 per cent, effective 3 March 2010.

Statement by Glenn Stevens, Governor Monetary Policy RBA: “The global economy is growing, and world GDP is expected to rise at close to trend pace in 2010 and 2011. The expansion is still hesitant in the major countries, due to the continuing legacy of the financial crisis, resulting in ongoing excess capacity. In Asia, where financial sectors are not impaired, growth has continued to be quite strong. The authorities in some countries are now seeking to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago and the extraordinary support from governments and central banks is gradually being wound back. Credit conditions remain difficult in some major countries as banks continue to face loan losses associated with the period of economic weakness. Concerns regarding some sovereigns remain elevated.

In Australia, economic conditions in 2009 were stronger than expected, after a mild downturn a year ago. The rate of unemployment appears to have peaked at a much lower level than earlier expected. Labour market data and a range of business surveys suggest growth in the economy may have already been at or close to trend for a few months. There are some signs that the process of business sector de-leveraging is moderating, with the pace of decline in business credit lessening and indications that lenders are starting to become more willing to lend to some borrowers. Investment in the resources sector is very strong. Credit for housing has been expanding at a solid pace, and dwelling prices have risen significantly over the past year. New loan approvals for housing have moderated a little over recent months, however, as interest rates have risen and the impact of large grants to first-home buyers has tailed off.

Inflation has, as expected, declined in underlying terms from its peak in 2008, helped by the fall in commodity prices at the end of 2008, a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. CPI inflation has risen somewhat recently as temporary factors that had been holding it to unusually low rates are now abating. Inflation is expected to be consistent with the target in 2010.

With the risk of serious economic contraction in Australia having passed, the Board moved late last year to lessen the degree of monetary stimulus that had been put in place when the outlook appeared to be much weaker. Lenders generally raised rates a little more than the cash rate and most loan rates rose by close to a percentage point.

Interest rates to most borrowers nonetheless remain lower than average. The Board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process.”

Every one talks “equity” but most don’t really understand what it is and how it can be used. So at a time when property prices have jumped forward by somewhere between 5-20% in the last 12 months, I thought it might be useful to have a look at what “equity” is and how you can use it to your advantage.

What is equity? Equity is the amount of your home that you “own”. In other words, it is the difference between what your home is worth and what you owe on your home loan. So the more you pay down your home loan, or the value of your house increases, the more equity you have.

In banking terms, not all equity is usable. As a rule, lenders will allow you to use up to 80% of the value of your home. So the usable equity is the difference between 80% of the value of your home and the balance on your loan.

For example: If your home is worth $500,000 and you owe $350,000 then you have $150,000 equity ($500,000-$$350,000). However, the usable equity is $50,000 (($500,000* 80%)-$350,000).

Banks may allow you to use your equity up to 90% of the value of your property but this will involve mortgage insurance – a cost that you need to consider before you take that step.

How can you use this equity? You can ask the bank to lend additional funds, over and above your home loan, to take your lending back up to 80% of the value of your home.

What can you use this equity for?  There are many things you can use your equity for. To provide the deposit for the purchase of an investment property, to refinance/consolidate personal loans or car loans, to fund renovations for your home, to buy a car, invest in shares, personal use (buy furniture, holidays etc).

Is there anything stopping me using the equity in my home? Banks will only allow you to use the equity in their property if you can show that you can service the debt in addition to your existing debts. This will come down to your income and commitments at the time. It does not matter how much equity you have in property, if your income is not enough to support your commitments, the bank will not allow you to borrow additional funds.

How do you structure lending to use your equity?  That really depends on your situation and the intended use of the funds. The new lending can be added onto the existing loan or could be set up as a separate loan. It is generally a good idea to not mix in the one loan lending that exists for different purposes e.g. lending to buy a home should not be mixed in with lending to buy an investment property. It is better to keep this lending separated into 2 accounts.

What are the costs to use your equity?  Rates and fees for the lending will depend on the ultimate structure and lender.