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Monthly Archives: December 2012

December 2012 – Points to Ponder


What is happening in our economy …………. How is the property market doing …………….. And a question – ‘Is your home your ATM???’ ……………………

Dear Readers,

Thanks to all of you for accepting our invitation, for accessing our blog, and for your participation & feedback. Your positive feedback inspires me to explore new ideas & topics. I look forward to more of your active participation.

A particular thanks to all of you who called up to comment and chat about the November 2012 Article (“What is the value of a Property”). A few of you were quite stirred up ……. Well, we started a conversation and got a few thoughts flowing ……… My purpose achieved.

One common thread, in the conversations we had, touched on how we saw our home as a store of value …… How we defined our financial well-being based on our home value …….
How we tend to depend on our home value to provide for our current and future cash flow needs ………
A sort of perpetual Credit Card or ATM ???? ……..

Part of a conversation with young couples ……… One of many I regularly have, got me thinking on the subject of this month, and a thought to ponder over the holiday season ……….

The Big Picture

Nothing dramatic has happened since the November 2012 article was written.
Europe continues in a limbo, the same old remedy of stimulus & debt making lesser impact ………
The non-election in the US, and stalemate in Washington, offers no fresh ideas or plan towards understanding and solving economic problems ……..
The “Tiger’ economies, in particular, and other global emerging markets in general do not yet show any trend towards sounder, long term growth strategies …………

The Australian economy, as explained in my previous blogs (July 2012, August 2012, November 2012), continues to flounder on, highly dependent on world commodity demand & prices …….., misplaced hopes of a consumer demand driven growth ……….., Mediocre economic management by our government …………, and now, a desperate hope that ‘infrastructure and construction’ activity will somehow lead our economy towards better growth.
The RBA has cut interest rates to a record low (GFC level) hoping to somehow stimulate the economy towards more debt, consumption, ‘investment’ and growth ……….
What is all the ‘Daily Media noise’ telling us ? …….. What are you hearing ? …………. What do you think ? …………..

More borrowing, more debt, more consumption ………. All of us are being told, is THE magic solution to overcoming our current problem ………. Which is partly a result of …….. Too much borrowing, debt and consumption …………..

This brings us to the topic of the month – “Is your home your ATM”?

‘My Home is my Castle’ – This timeless saying is a bedrock of our thinking. We are a nation of home owners, and the Australian dream of aspiring towards ‘The Dream Home’ is central to what we are and what we do.

Our home & property value is a predominant subject of curiosity, talk, speculation, etc. To buy, and borrow against, our property is probably the most prominent & biggest decision we make, at the earliest stage of our productive lives.

Our home, being central to our family life & well-being, gets a lot of attention. We take pride in what we buy, where we buy, how it looks ……….. And we are constantly aware, or being made aware, of home prices; current & future ………..

As explained in my previous blog (November 2012), we tend to feel the ‘Wealth Effect’ ……… Of being better off, more secure, wealthier …….. If we are convinced that our property is ‘worth’ more compared to when we bought it.

“We paid $500,000 for our home (contract price), we have done a lot of spending on it over the last few years, and they now say it is worth $600,000 …………. That’s a cool 100 grand ……… Not bad”.

‘They’ could be our neighbours, family & friends, Newspapers, Online media, our friendly local Real Estate Agent, etc. ……….. And it is reinforced regularly …….. We talk about it, a nice part of our conversation at almost any occasion.

And it gives us a sense of achievement, self-congratulation ……. A sense of ‘We are doing alright’.

And, in most cases, this is the ‘Starting Out / Growth’ phase of our lives – Just started / Growing Family, Growing Career, Growing Kids ………….. And growing needs, wants, wishes, aspirations …………..

And there is never enough time, We want to do so much right now ………. We want to keep everyone happy ……… and of course, there is never enough money ……….

“Some things have to be done now, We need it, We want it, Let us just do it …….. If we need to borrow, so be it ………. We are all right, We can manage it” ………

‘The Wealth Effect’, in part, gives us this confidence ……….. Our perception of increased property value can assure & convince us to borrow more, go into more debt ……….
It can also, if we are unaware, balance out the caution we may naturally feel when borrowing more.

And our ‘Friendly Banker / Financier’ is standing by ……… ‘You have equity in your property, yes, we can organise something for you easily’ ……….

The Cost of Home / Property Ownership

Let me introduce to you Shaun & Sarah. Both in their mid 20’s, grown up in comfortable, loving homes, have been gainfully employed over the last few years, and are now planning to start a family of their own.
They have managed to organise a 5% deposit for their new home, and have decided to buy a property for $500,000.

Let us assume that they end up borrowing $475,000 to purchase their property …………….
Assume the $25,000 they have goes towards a deposit (Down Payment) ……………..
Assume the ‘Initial Costs’ of purchasing as approx. $37,000 …………..
Assume they settle down comfortably into a minimum monthly repayment schedule ………….

Now, let us fast forward to 5 years down the track ……….. Shaun & Sarah have managed a comfortable & relaxed lifestyle and are, on a weekend, discussing their wants & needs ………….

‘It’s a good thing we bought this property 5 years ago ……. We probably would still be living with Mum & Dad if we hadn’t’ …………
‘There are these few debts we have, on top of the home loan ……… and we want some more money to do a few things right now’ ……….
‘We will need to borrow a bit more, but it’s OK ……….. Look at what that Real Estate Agent said the other day’ ………
‘Seems our property could sell for more than $730,000 ………. Isn’t that wonderful …….. a cool 230 grand profit’ ……..
‘We are all right ………. Let’s just put all our debts onto our home loan ……….. And borrow a bit more that we need right now ………. And it should be all right’ ………..

Sounds alright, doesn’t it ? After all, it seems like they are sitting on an increased property value ………

But hang on ………. There were a few facts we missed ……… the property (and the mortgage) had to be managed/serviced over the last 5 years ……… Minimum monthly repayments have been made to the Bank over the last 5 years …………

Assume total repayments (over 5 years) towards the mortgage as approx. $193,000 ……….

Now let us add up the Total Cost of Ownership: $500,000 (purchase price) + $37,000 (costs of purchase) + $193,000 (total repayments) = $730,000 ………

‘But, that is the same as the current value of the property ………. You mean there is no profit’ ??? ……..

This is what the ‘Wealth Effect’ can do to us, if we are not careful. Yes, the property has gained in value over the 5 years.
Yes, the friendly Bank / Financier may be more than happy to lend Shaun & Sarah more and more against their property ……….. That is what Banks do for a living …….. Don’t blame them ……….

The gain in property value has already been paid for, in full, by Shaun & Sarah, with their hard earned ‘After Tax’ income, over the last 5 years ……….

Remember, an increase in our Property Value over time does not equate to money in our pocket ……… But, can end up as Debt on our balance sheet ……………

Come on Hari ……..
What if they did rent for those 5 years ………….
They repaid the loan with the $193,000, surely? …………
They would have saved the $193,000 over the 5 years, if they had not bought property ……….

I have made some counter comments, to start off a conversation with you. I am sure you will have many more counter arguments & points to make. I will look forward to a robust discussion.
Please note I have made many assumptions and have done detailed calculations to arrive at all above figures. Pl email me, I will be more than happy to work out specific scenarios with you.

I hope the blog is challenging enough to start all of you thinking ……………..
I will leave the forum open to you now ………… What are your thoughts on all of this ?
What is your experience ?
Come, join the discussion, share your ideas & experiences …….
I look forward to your opinion, counter argument, response, constructive criticism, feedback, etc.

PS: Don’t worry, I will try my best to make sure Shaun & Sarah learn from this scenario …………

Looking forward to hearing from you and wishing you all a Very Merry Christmas, Happy Holidays, and a Prosperous & Healthy 2013 …………..

Hari

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Posted by on December 8, 2012 in Uncategorized

 

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