Your bank has a dirty little secret

Guest observeration

Recently I read two very different articles about our 'property markets'.

The first was an in depth piece by arguably Australia's most accurate property analyst, Michael Matusik. The second article was attributed to the chairman of Century 21 Real Estate, Charles Tarbey. Both articles rammed home why the average Australian finds it difficult to know (let alone understand) what's really happening in 'the property market'.

Matusik suggested that "caution and common-sense" are the order of the day for owner occupiers and investors alike (along with investing for rental income of course).

Tarbey on the other hand declared that there was no bubble in Australian real estate, and that "we're in a very steady adjustment growth mode driven by the shift to a market where buyers and sellers negotiate a fair price". Caution and common sense?

Neither pundit addressed this point though: your bank has a dirty little secret (weapon) that they can't wait to use on you.

Our current low interest rates and housing shortage issues have lured thousands of people each week into paying 'whatever it takes' to get into a property, especially in Sydney and Melbourne. There's so much evidence of this that it's just plain scary.

Whether you like it or not, Sydney is the undisputed engine of Australia. Melbourne comes in second and not-so-sleepy Brisbane is third in line.

So let's take a close look at Sydney, shall we? With 4.35 million residents, the largest workforce, strongest Gross Domestic Product (GDP) and highest home prices in the nation. House prices (in Sydney and every other overheated market) are poised for a serious downward adjustment, not if, but when interest rates go back up from their current 50 year historical lows.

Most people flocking in to buy a home today don't understand that an interest rate of 6.70% isn't just a "bit more"; it's a whopping 37% extra interest each month.

How will life change for an average Sydney couple with a $400,000 mortgage currently and 4.89% interest rate? Their current monthly repayment is $2121 with an interest component of $1630; and they're paying the principal down by $491 a month. It will take them 30 years to own that home at that rate.

But what happens when their interest rate goes back to 6.70% - still well below the long term average?

Have a look at the 'smoke & mirrors' their bank uses to hide its dirty little secret. Although the monthly repayment for our Sydney couple jumps by $460 to $2581, the interest component jumps by almost $150 more, from $1630 to $2233.

The interest component on their loan is now $112 a month more than their previous principal and interest repayment.

Their interest is now $603 higher, however their monthly repayment only increased by $460. Even though their monthly repayment jumped by almost 22% - the interest component jumped by 37%.

Hello, did you see that: they've gone from paying almost $500 a month off, to now only reducing the debt by just $348 each month.

Kiss that 30 year repayment period goodbye!

Score 1:0 to their bank, who win big time, with each rate rise working in their favour.

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So I simply cannot agree with Tarbey's view. When people are competing in record numbers, for the few properties available, and prepared to pay above the odds to secure a place to call home, then common sense has gone out the window.

I know we're in a bubble right now, when real estate agents tell me that the house I bought for $680,000 just over five years ago would probably now fetch $1.1m.

I know we're in a bubble right now, when real estate agents tell me that they'll now accept "offers over $280,000" for the two bedroom units I was buying for investor clients 21 months ago for $200,000 - and their rents have either remained static or dropped $10 a week in the process.

I know we're in a bubble right now, because my house hasn't increased in value by over $500,000 or 73%. I know we're in a bubble right now, because those two bedroom units haven't increased in value by $80,000 or 40%.

I also know we're heading for a severe correction in those markets because:

• This insanity is driven by an abundance of cheap money
• The supply component is out of synch to match the demand caused by the abundance of cheap money
• Money is the cheapest it's been in over 50 years because our economy is in trouble
• Borrowing to the hilt because you can afford to pay whatever it takes for 'that' property based on today's interest rates is maybe the new definition of insanity

Michael Matusik, I think you're closer to the truth than even you might know.

What should you do right now? A couple of things, actually:

• Get rid of all that credit card debt, personal loans, and any other high interest rate facilities
• If you can't get rid of that debt, if you've got enough equity in your home consider rolling those debts into your home loan. Better still, roll them into a separate facility and pay it off over say three to five years
• Seriously consider switching your home and/or investment property loan to either a three or five year Fixed Rate loan - sooner rather than later
• Pay more than the minimum repayment on your home and/or investment property loans; in fact use these ridiculously low interest rates to pay as much extra as you can afford
• Right now, the smartest thing you can do - for you - is to reduce debt fast. The lowest interest rates in five decades is your best chance to do this, probably in five decades.