A Cash Hole


By Ben Pauley

"Interest Rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices." - Warren Buffet

I was speaking with a friend of mine last week, both of us work in finance and naturally we got to speaking about the state of the world and what is happening in the housing market. He mentioned to me about his personal situation and how he was cutting back on expenses. He and his fiancé, over the next few weeks, will come off interest only on his home loan and is refixing his mortgage. Between the change in interest rate and additional principal payments, his mortgage payments are going to go from $400 per week to $1,200 per week.

You have done the math right, that is an $800 increase in their payments each week. $40,000 per year. That is HUGE.

Now, my friend and his fiancé are reasonably well paid and I don’t think they are panicked. However, I did begin to wonder what the equivalent might mean for the average punter.

If we said the average mortgage for a homeowner is around $600,000, then they could have secured a home last year and fixed for 12 months at 2%. That means their weekly mortgage payments would be ~$230 on interest only.

If they then look to refix today, for say a further 12 months, the current 1-year rate is sitting at about 4%. That would double their mortgage payments (another $230 per week). But if they also had to move onto Principal and Interest it jumps to ~$660 per week, almost triple the amount. That is the equivalent of an increase of ~$22,375 per annum.

Now, it isn’t all bad, as a portion of that cash outlay is repaying debt. However, what will happen to that person’s spending habits? I have commented on earlier blogs that the average Kiwi’s savings p.a. is 0.50% ($500 on a net $100,000 salary). With that in mind, it is unlikely this person was already saving (not consuming) 22%+ of their salary (that $22,375 increase). It is likely they were spending that money on dinners, holidays, wine, clothes and other activities.

As mentioned earlier, my friend and his partner are going to reign in their spending. I imagine many others will be as well. All this at a time when we are looking to reduce restrictions on travel and mandates in a bid to kick start the economy again. I do wonder whether we will see a corresponding return of activity with the opening back up of the country. Will homes continue to rise in value when debt costs so much more? We have taken on a massive amount of leverage as a nation in the last 18 months, and at some point we need to knuckle down and repay that debt.

It does make me wonder whether we will continue to see rate hikes and tightening of monetary policy. The Reserve Bank could well be faced with a choice between two evils, combat inflation and prick the bubble, or spur economic growth (and maintenance of asset prices) but allow inflation to run riot. I don’t know which option they will consider the lesser of two evils, it may depend on the size of their mortgage! What I do know is that we are in for an interesting 12 months and good advice is paramount.

If you’re looking at getting onto the property ladder but don’t know where to start in this current climate, don’t hesitate to get in touch- we’re happy to help.

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