Sailing close to the wind...

[HiEquity]

On another thread I noted the following comments which I thought worthy of their own thread:

But of course; that's not what people do; you've gotta borrow as much as you physically can, pay the minimum repayment (because you're at your borrowing limit) and hope like hell the interest rates don't go up.

This would explain why a .25% change, or a jump in the price of petrol each week, sends so many screaming into the streets with shouts of.... "OMG!...how will I afford the groceries now?"

Requoted for truthiness

OK, so I can imagine there may be some people who do this. But I am interested in how many actually push things to this extent? The fact TF has agreed with this statement so strongly makes me question my previous assumptions which were that the majority of Australians would be pretty conservative on their personal borrowings and this level of pushing the limits would be restricted to only a relative few.

I note however that servicing tests from some lenders in particular do allow homebuyers with a steady job and no other assets to still sail very close to the wind in terms of spare cash flow over mortgage payments for personal expenses. When I compare this with the difficulty for investors with passive incomes exceeding the active incomes of others to get finance it leaves me scratching my head. But I can see that there is probably a much bigger market of loans for the homebuyers instead of investors so the pressure to relax standards in this area to gain market share off others (within regulatory limits) would be much higher. And no doubt banks would be happy for salaried folk to devote the majority of their working lives to paying interest to the bank...

So, a question for the bankers and brokers out there who deal with the "average" (that can mean whatever you want it to mean) first homebuyer or "mum and dad" upgrader - what proportion of these clients would go for broke (quite literally...) like this?

BTW I classify investors extending themselves to buy quality assets with strong cash flows in a different (more entrepreneurial) bucket. Really only interested in the proportion of people extending themselves to this extent for your more "garden variety" PPOR buyers...

Thanks in advance for any comments / experiences.

 

[pennyk]

we did push ourselves to that extent with our first IP purchase, partly because we had people doing financial analyses for us which were flawed, so that we bought an IP which cost us alot more than we thought it would.
later down the track, when I worked briefly for a property marketer, I realised that what they do is use the somersoft software, but they put all depreciation into year 1, so it looks like the commitment you have to make is $20 or $50/ week, when its actually closer to $100 or more.
we sold that IP after a couple of years and invested more conservatively after that.

 

[Paul Thewlis]

Don't believe too much of the media hype which would have you believe every household is mortgaged to the hilt. Official Reserve Bank Figures put the average LVR across the country at 29.7% as of December 2011.

That includes investors which according to ATO figures constitutes about 13% of taxpayers and who you would expect to be more highly leveraged than owner occupiers.

If you go back 20 years that the LVR was 13.1% so on average the debt level has grown significantly but we are not all mortgaged to 90%.

Regards
Paul

 

[HiEquity]

Hi Paul

I'm not too concerned about LVR here - more about servicing. A 90% lend with excellent servicing is far less risky in my book than a 50% loan with razor thin servicing. Not risky to the bank necessarily of course - more to the homebuyer.

I can easily imagine the majority of existing owners, who would mostly have bought awhile ago at lower prices, would also not have high LVRs. But I'm not talking about the position of the average homeowner out there either - more about the position of current homebuyers.

My question relates to the behaviour of "average" people taking out new PPOR loans now and how many sail really close to the wind like this with their servicing?

 

[handyandy]

Your 'sailing close to the wind' reminds me of a PA i had some time back. (early 1990's so very high interest rates)

Every month was a drama for her ensuring that there was enough money in her bank account to pay the mortgage. Her husband was self employed and I think this was part of the issue. None the less they had obviously signed up for a mortgage that really put them on the razors edge.

At that time the Govn then started reducing interest rates and instead of this lady taking a breath and relaxing she and her partner sold up and bought a more expensive property.

When questioned about this her answer was 'we can now afford a larger mortgage'.

Conclusion - they really liked living on that razor's edge.

All turned out OK as interest rates continued to decline but what if they hadn't.

Cheers

 

[devo76]

I think it's important to factor in what people do with their cash AFTER the mortgage has been paid. Many live on the razors edge because of spending habits. They have no real appreciation of the what if's in life. I have more breathing space than many of my employees with far smaller loans.
And I'm not immune to impulse spending. I just know what I can spend abd what I can't. And much of my savings I can't for sanf. This is the area that many people don't be careful and leave themselves exposed to lifes hiccups.

 

[INVSTOR]

I know a couple of people like that. They both constantly spend heaps of money on extensive renovations on their PPOR's in very average suburbs. They constantly refinance and pull out more money whenever their property goes up in value. Both of them have been bankrupt or close to it at least once before and seem to do the same cycle over and over again. One of them recently had to sell their PPOR (possibly to avoid going bankrupt again?) and the other one is on interest only for a year on PPOR and have just spent about $45000 on upgrading their cars. They complain they have to stay home all the time and sometimes don't have enough money for groceries or a a haircut. They've just ordered heaps of materials to do more renovations and are madly trying to save to pay for them and keep putting off delivery as they don't have the money. They both do stuff like purchase $100 bottles of wine also.

 

[wobbycarly]

Your 'sailing close to the wind' reminds me of a PA i had some time back. (early 1990's so very high interest rates)

Every month was a drama for her ensuring that there was enough money in her bank account to pay the mortgage. Her husband was self employed and I think this was part of the issue. None the less they had obviously signed up for a mortgage that really put them on the razors edge.

At that time the Govn then started reducing interest rates and instead of this lady taking a breath and relaxing she and her partner sold up and bought a more expensive property.

When questioned about this her answer was 'we can now afford a larger mortgage'.

Conclusion - they really liked living on that razor's edge.

All turned out OK as interest rates continued to decline but what if they hadn't.

Cheers

Agree with this. If Mr and Mrs Average (or should that be Mr and Mrs Median? ) go to the bank, have their finances run through the servicabalility calculator and get told "You can afford $400,000", do you think they'll go looking at properties at $350k? More likely, they'll look at some $400k properties, and then stumble across the "perfect place" that costs just that little bit more... So they push the envelope, because they "deserve" that nicer place, don't they?

 

[BayView]

Don't believe too much of the media hype which would have you believe every household is mortgaged to the hilt. Official Reserve Bank Figures put the average LVR across the country at 29.7% as of December 2011.

If you go back 20 years that the LVR was 13.1% so on average the debt level has grown significantly but we are not all mortgaged to 90%.

Regards
Paul

Maybe so.

But if this is all true, then why does the average day-to-day Mr&Mrs Thong wail when the price of fuel spikes 10c a litre every Tuesday, and why do I often hear through my customers how no-one is going away for hols at Easter/school hols etc due to fuel/energy price increases, the exponential rise in bargain hunting for stuff on Ebay, the explosion of $2 shops around the place, supermarket specials brochures....and so on infinitum.

My guess is that truthfully; most people are about half a month away from broke - no matter what the income level... but will never admit it.

I see it every day with our workshop, and I reckon it is a good indicator of how the normal folk go;

cars that are stuffed, bald tyres, haven't been serviced (overdue for) for 20,000km's, and still the owners want us to do the absolute bare minimum to keep it on the road, or the BMW driver who comes in for new tyres, and instead of going for the OE top-of-the range Michelins, or Continentals etc, they go for the almost bottom of the range option, because they can't afford the expensive ones etc.

We have an unwritten policy in our workshop for unforseen repairs required when someone brings their car in for a service - if it is going to cost them more than $50 they weren't expecting to spend on their service, we call them up first. Why? Because $50 to almost everyone is a significant change to their budget.

This has evolved from past experiences with doing something to the car they weren't expecting, such as the in-tank fuel filter needed replacing etc. They get upset when they find out they have to spend more. But, in most cases; if it around $50 more, or a bit less, there never seems to be much of an issue.

If that's the case; I reckon people aren't traveling too well if $50 is a big deal in the scheme of a $200 or $250 bill.

 

[Rolf Latham]

Hiya

I cant comment on the generalities because Idont have the general client base.

These are my observations

1. The lower socioeconomic groups will do more to hold onto a PPOR, than your middle and upper middle class will to hold an IP. A higher income earner is often not as intimidated by collections people / process.

2. In the rare instances where I have had clients with cashflow issues to the point of foreclosure it has not been due to cashflow mgt per se. Long term PAYG income loss due to lack of availability of "suitable" work, business failure, illness, or relationship breakup is more common.

3. Where bad money habits have contributed to arrears, and its not due to the 4 issues above, EVERY time its been due to further debt taken on by the borrowers post mortgage. Some would argue that if the mortgage wasnt there in the first place, the need for that additional debt would not have arisen.........maybe, though thats a diff chat altogether.


Ultimately, I have found most people to be financially sensible, but a little blind to the realities of life, and its those blinkers that then cause them problems.

ta'rolf

 

[MichaelW]

Hi Guys,

I can say in all honesty that my servicability is sailing very close to the wind right now. If I pinch up another inch I'll get knocked into an unplanned tack... Sailing vernacular.

But that's only because I'm almost fully drawn on my construction loan for my Mona Vale project but am yet to complete and get tennants in. Right now I'm paying $10K a month in servicing the construction and land loans without any rental income to assist. My salaried income (thanks to my ITWV) only just covers it. Its nice paying 4% tax!

I knew this would become a problem at this stage of the project, but even now my cash in exceeds my cash out monthly. But only just. I have a $100K cash buffer in the bank still which means I'll have no problems seeing the project through to completion, but the cash flow strain is significant.

In a few months time, when strata'd and my loans on the build are reduced to a 6.5% odd resi interest rate from my current 8.5% commercial rate I'll be much better off. Add three additional rentals into the mix and cash flow goes from -$120K odd pa to marginally positive on the IPs. Suddenly all that salaried income becomes mine to keep again, but of course I start paying more than 4% tax at that point too.

All good, but offered up as an example of how, at times, some of us do sail very close to the wind for very specific reasons.

Cheers,
Michael

 

[Andrew_A]

Interesting reading, lot of wisdom in this thread. In times of strong growth all of these cracks in the structure can be papered over more easily but when the growth in asset values isn't there.. for sailing close to the wind I can't think of a better read than Alan Bond's biography.

 

[devo76]

Hi Guys,

I can say in all honesty that my servicability is sailing very close to the wind right now. If I pinch up another inch I'll get knocked into an unplanned tack... Sailing vernacular.

But that's only because I'm almost fully drawn on my construction loan for my Mona Vale project but am yet to complete and get tennants in. Right now I'm paying $10K a month in servicing the construction and land loans without any rental income to assist. My salaried income (thanks to my ITWV) only just covers it. Its nice paying 4% tax!

I knew this would become a problem at this stage of the project, but even now my cash in exceeds my cash out monthly. But only just. I have a $100K cash buffer in the bank still which means I'll have no problems seeing the project through to completion, but the cash flow strain is significant.

In a few months time, when strata'd and my loans on the build are reduced to a 6.5% odd resi interest rate from my current 8.5% commercial rate I'll be much better off. Add three additional rentals into the mix and cash flow goes from -$120K odd pa to marginally positive on the IPs. Suddenly all that salaried income becomes mine to keep again, but of course I start paying more than 4% tax at that point too.

All good, but offered up as an example of how, at times, some of us do sail very close to the wind for very specific reasons.

Cheers,
Michael

Im in the same position but a much smaller scale.
My development ( house reno,house construction then subdivide) has me somewhat exposed at this point. I have spent all of my lock and building is about to commence adding more interest payments. Rent will not be achieved for about another 6 months. All part of the plan but its still a pain.
I still have my cash buffer but its not to be spent on investments. Its my life buffer.
Once done i will have a positive investment property and a large chunk of manufactured CG.
As said above. Some sail close for a reason.

 

[beachgurl]

I've found that the ones skating that close to the edge are those that maxed out their borrowing capacity on two incomes with the brand new house and land packages and then the wife stays home after having a baby. There have been a number of people in my circle that have rented out their home to rent somewhere cheaper to pay the mortgage. One has now sold their home and I know another couple who are about to put their place on the market.

 

[james start]

i worked with a guy that had 3 properties and after all expenses at the end of the week he only had $30 left over, his girlfriend at the time gave him a ultimatum to sell a house or she would leave him......so she left him

 

[lizzie]

We were nearly sucked under by a sudden change in wind direction whilst sailing high on the point.

Leading up to 2003 - boom period - was advised by (then) acct to purchase in discretionary trust - sailing along nicely buying, reno-ing and selling - culminated in two buy, knockdown, rebuild and sells ... the the crash hit - mere weeks before our build was finished.

Couldn't sell to save ourselves and ended up chasing the market down - in desparation we put in tenants - who then trashed $8k worth of carpet - rent didn't come close to paying interest in the construction/land.

We could've made it but - then 6 months later - massive land tax bill arrived (didn't realise no threshold in trust) backdated several years.

Land tax paid on credit card - vicious cycle in itself - threw tenants out - fixed up trashing and put back on the market at firesale price - sold and settled with mere weeks to spare.

Still paying off some of the related debt.

 

[HiEquity]

Hiya

I cant comment on the generalities because Idont have the general client base.

Hi Rolf

Going by the lack of response from brokers to this thread, it seems that would be the case for most of them who advertise, I mean post, on this forum.

Thanks for the response of those who did take the time though. Obviously there is a clear market differentiation between IP brokers for a small section of the market and your run of the mill PPOR brokers for everyone else, who wouldn't hang around here much.

 

[beachgurl]

I had an ex client call me today (I don't write loans anymore) who borrowed to his max a few years ago and now requires a loan increase to buy a new car. His car is only 3 years old but he needs a new one. Then he admitted he also needs to pay out 20k in credit cards from spending up big on the house and now he can't afford the credit card bills and the mortgage. I'd feel I'll living life like that but this guy has been doing it for a few years and thinks nothing of cutting it that fine.

 

[Rolf Latham]

I had an ex client call me today (I don't write loans anymore)

so who is the ex

the client

or

the broker

ta
rolf

 

[Marty McDonald]

Hi Rolf

Going by the lack of response from brokers to this thread, it seems that would be the case for most of them who advertise, I mean post, on this forum.

Thanks for the response of those who did take the time though. Obviously there is a clear market differentiation between IP brokers for a small section of the market and your run of the mill PPOR brokers for everyone else, who wouldn't hang around here much.

I don't disagree with that completely however its more about fitting a round peg in a round hole. Lenders do have different things they are adverse to from a risk point of view. The more complex a borrowers situation the more diverse the differences can be between lenders policies.

In general i also think many ma and pa, one propery borrowers do sail close to the wind. Keeping up with the joneses is a powerful motivator.