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Don't get caught in the first-home trap

Don't get caught in the first-home trap

Thousands of Australian homeowners risk being stuck in their existing home because falling property prices have eroded or even wiped out the equity needed to move on to a bigger house or unit.

Home values have fallen in every major city by as much as 6.8 percent, with median capital city prices down 3.6 percent in the year to December 2011, according to RP Data. Regional property prices (median) dropped by 2.9 percent in that period.

Those most at risk will have bought in the booming property market of 2009 and 2010. But a significant portion of recent property buyers looking to sell up and move on, or refinance, could be in for a nasty shock.

Damian Smith, chief executive of RateCity, said we often hear about the plight of first home buyers, but there are a number of home owners doing it tough.

“Let’s say you purchased a unit in a major Australian city last year with a purchase price of $400,000. Imaging you took out a home loan with a rate of 7 percent and put down a deposit of 5 percent, so you end up borrowing $380,000.

“By the end of the first year, you’ve paid a total of around $30,400, of which around $5000 is principal – so your mortgage is now just under $375,000. But when it comes time to sell or refinance and you want to shop around, you may be in for an unpleasant surprise on valuation,” he said.

With a 3.5 percent decline in value a once $400,000 property is now valued at just $385,600 and around 3 percent equity in the home.

Not every suburb in Australia will look like this scenario; Sydney’s median property, for instance, lost just 0.3 percent in value in the year to December 2011. But there are regions which have been hit hard by declining property values where ‘negative equity’ is a very real issue.

Brisbane house prices plunged 6.8 percent, while Melbourne’s median price dropped by 6.1 percent in the same period. At this rate, Brisbane and Melbourne residents with the same $400,000 property will have little, if any, remaining equity to use as a deposit for a more expensive future home.

Meanwhile, credit rating agency Standard & Poor’s has warned that a slowdown in China’s economic boom could cause Australian house pricess to slide by more than 5 percent this year.

“Very few lenders will be willing to lend you 100 percent of the value of any property, especially one where there’s still risk about further property value declines,” said Smith.

If you are at risk of a negative, or near-negative, equity situation, here are a few practical tips:

  • When interest rates fall, keep repayments up at the previous level to eat into your principal faster and increase repayments when rates remain steady
  • Having a much bigger deposit before you go to borrow in the first place is always a good idea
  • Keep an eye on the market and regularly compare home loans online and use this knowledge for greater bargaining power with your current lender
  • Anyone on an interest-only mortgage should switch to repayment where possible – it will be more expensive in the short term, but could save you thousands of dollars down the track.

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