The ‘pros’ and ‘cons’ of expanding home loan guarantees
By Eliza Owen, Head of Research at CoreLogic Australia
Home ownership in Australia is rooted in wealth accumulation, security of tenure and security in retirement. In other words, home ownership in Australia makes life much easier in the long run than renting. While surveys indicate that most Australians want to own their own home, the latest data available shows that only 66% of households do.
As we head into the next election, Labor and the Coalition have included some expansion of the First Home Loan Deposit Scheme (FHLDS) in their policy platforms:
- Labor has proposed a First Home Buyer Support Scheme, which will review price caps every six months and provide 10,000 government guarantees to regional Australian applicants.
- The Coalition would also set aside 10,000 home loan guarantees for Australians in the region, but would widen eligibility in the regions to non-first-time buyers and limit purchases to new homes.
- The Coalition would also increase the current 10,000 regular FHLDS places to 35,000 per year. The family home guarantee would also be increased to 5,000 spaces per year, creating a total of 50,000 new low-bond guarantees in 2022 alone.
How does the diet work?
In its current form, the FHLDS allows eligible borrowers to take out a mortgage with as little as 5% down payment, without paying mortgage loan insurance to lenders. This is done by the government guaranteeing up to 15% of the loan.
Applications are limited to singles with income up to $125,000 or couples with $200,000. Purchases under the scheme are limited to between $350,000 in some areas and up to $950,000 in Sydney for new homes.
But whether the schema is “good” or “bad” is a really complex question. Some of the pros and cons of the diet are outlined below.
Benefit: This (roughly) quadruples the time it would take to save a deposit
Based on the median home value in Australia at the end of February ($728,034), CoreLogic estimates that it would take the median household about 2.3 years to save a 5% down payment on a house (Figure 1.0). A 20% deposit, which is the level for borrowers to avoid lenders’ mortgage insurance (LMI), would take about 8.8 years.
This could reduce the rental market by 6.5 years, which at current weekly values of median housing rents in Australia is equivalent to almost $160,000. IMT savings could exceed $30,000 on the median Australian home value with a 5% down payment.
Disadvantage: Interest charges would be higher
Understanding the concept of interest is crucial to performing a thorough cost-benefit analysis of the scheme.
Taking the median home value and the current average mortgage rate for homeowner borrowers (2.44%), the difference in interest charges between a 5% deposit and a 20% deposit is approximately 37 $000 over the life of the loan (Figure 2).
With the cash rate likely to rise over the next 12 months, this will exacerbate interest between those with a 5% and 20% deposit loan. Understanding interest is extremely important when taking out large mortgages, particularly when targeting these programs to young Australians and women, where financial literacy rates among these groups tend to be lower.
Although the interest charges on a 5% deposit home loan may be higher, it is important to weigh this against the cost of not being in the market. These charges include any increase (or decrease) in purchase prices and rental charges.
Pros: More than one in three established properties qualify
Based on the scheme’s current price caps for established properties, CoreLogic estimates that around 35.4% of Australian homes are eligible. If prices fall, this could free up more homes for applicants, while the reverse is true if prices continue to rise.
Disadvantage: price thresholds are difficult to determine
A drop in house values would increase the number of properties available under the FHLDS, but the fast-moving and diverse housing market in Australia means that inventory availability varies widely from region to region.
Figure 3 shows the current share of assessments that fall below the purchase price thresholds established for the program in each region, as of the end of March. CoreLogic’s analysis shows that the proportion of eligible properties ranged from 66.3% of homes in Perth to just 10.7% in the ACT.
Purchase thresholds have been adjusted upwards in the 2021-22 financial year, and Labor has indicated that it intends to review the program purchase caps every six months, so that this policy can be adapted to changing market conditions.
For: It’s not a revolution, but it’s pragmatic
The FHLDS is not revolutionary. While the 2016 and 2019 federal elections saw Labor campaign on negative debt changes and capital gains concessions, both parties are trying to help first-time buyers overcome the deposit hurdle, ” while protecting home values.
To date, the program has seen very high demand. Within four months of the start, more than 8,000 places in the program had been filled. The ABS data also shows that first-time lending to homebuyers surged from the start of 2020 (Chart 4), coinciding with the launch of the program.
Disadvantage: It could do better on the equity front
Australia’s homeownership rate fell from around 71% in 1995 to 66% in 2016. But, as the Grattan study notes, lower homeownership rates are associated with lower incomes. weaker. This means that tackling low homeownership rates should target low-income households.
The income thresholds for the FHLDS are relatively high. For example, ABS data on household income and wealth showed that in 2017-2018, a gross household income of $200,000 per year placed households in the top 20% of income earners, and that the median household income was closer to US$88,000. Couples earning up to $200,000 may qualify for FHLDS, although figures suggest their risk of missing out on homeownership without it is lower.
According to the NHFIC, however, the highest concentrations of guarantees have been below income thresholds through 2019-20, between $60 and $80,000 for singles and between $100 and $125,000 for couples. Purchase price caps can also have a self-selection effect, with higher income earners looking for more expensive homes.
Pros and cons: This will increase housing demand at a time when the housing market is cooling
Historically, targeted subsidies for first-time homebuyers have enticed buyers. Figure 4 shows how the temporary boost from the first homeowner subsidy increased housing activity at the time of the global financial crisis in 2008, when an increase in real estate transactions had a positive impact on the economy.
The expansion of the FHLDS could increase the number of first-time home buyers at a time when the outlook for the housing market is uncertain. Alternatively, it could increase demand for more affordable properties, driving up prices in this segment.
A Final Word About First Home Buyers
Should first-time home buyers be worried about the prospect of a falling market? Probably not. The risk of negative equity is mitigated by the fact that homeowners hold their properties for long periods and the Australian labor market is at its highest level in 50 years.
CoreLogic’s resale analysis shows that homeowners have a median holding period of around nine years.
Historical performance of the Australian housing market has shown that peak to trough declines last an average of 12 months nationally. The RBA also recently produced analysis showing that first-time home buyers were no more at risk of mortgage arrears than other borrowers. Negative equity becomes a greater risk when mortgage repayment capacity deteriorates. That’s why a thorough assessment of borrowers is so important in an environment where rates are set to rise.
If there’s a limit to the expansion of the FHLDS, it’s likely to be in the details of refining income and price thresholds, rather than major default risks for first-time home buyers. Regardless of which political party wins the 2022 election, a housing policy goal should also focus on more equitable housing outcomes across all income brackets, including the adequate provision of affordable housing for those who have little chance of owning a property.