What happens if property prices drop after I buy?
It doesn’t matter how many opinions you ask for when you’re looking to enter the property market. Only one thing is certain: no one knows anything for sure. When the Global Financial Crisis hit, few Australians had any understanding of what was occurring in the US property market, so there is little reason to believe someone will accurately predict the next fall.
Let's use the median house price trends following the GFC and the example of newly engaged couple Kate and Mark who purchased a two-bedroom apartment in Hawthorn, Melbourne. They bought in 2010 at the median house price of $561,000, with a 10 per cent deposit. They started with a $522,000 loan ($505,000 base loan plus Lender’s Mortgage Insurance of $17,000 due to a deposit of less than 20 per cent), giving them $39,000 in equity.
By the end of 2011, the median Melbourne house price had fallen by 13 per cent. On average Kate and Mark’s apartment would have fallen in value to $488,000. Their home loan after a year of repayments would have been $512,000, making their apartment worth $24,000 less than the loan.
If Kate and Mark decided to sell their apartment for $488,000, they would have to pay the $24,000 difference between the loan and the sold price, plus real estate agent and solicitor fees.
Before the property could be sold, Kate and Mark’s lender would want to see evidence that the couple could pay the $24,000 difference and seek a statement such as cash held in an account, or an asset that could be converted to cash, like shares.
Fortunately for Melburnians, the median property price recovered in 2012, bouncing by 10 per cent. Not enough to recover the decline of the previous year, but in Kate and Mark’s scenario it would have meant their Hawthorn apartment value rose to $537,000 by the end of the year with a loan of $503,000, giving the couple equity of $34,000.
If Kate and Mark had of started with a 20 per cent deposit, after the first year of decline their loan $440,000 against the reduced house price of $488,000, they still would have had $48,000 in equity.
It’s worth noting neither Melbourne or Sydney have experienced more than two consecutive years of median property value decline since before the 1970’s. The 13 per cent fall in 2011 is the worst dating back to 1970 for Melbourne. Add Sydney’s 1990 -17 per cent fall, and these represent the only double digit decline in a year for either city.
The last thing any lender wants is to force the sale of owner-occupied property. The good news is, if you’re still in a position to make home loan repayments, you actually aren’t likely to hear from your lender, especially if your property fell in value, but the rest of the market didn’t. This makes the change largely imperceptible to the lender.
Given most owners would do anything to avoid selling at a loss, the question becomes, what are the chances you may have to sell? And what options would you have?
The most likely scenario for most people to consider selling at a loss, would be a loss of employment, injury impacting their ability to work, or a relationship breakdown. All lenders have a hardship policy where owners can request a temporary pause or reduction in repayments.
Like most things, the key is to be on the front foot, getting the lender’s support will be easier as soon as a change in circumstances occurs, but before any repayments are missed.
One of the big advantages today’s property owners have over those of yesteryear, is the speed and multiple ways to generate an income from their property. Whether that is renting out a room, short term Airbnb or a permanent rental. Generating some income or potentially staying with family may be enough to get through a challenging couple of years.
Ultimately, a property is a long-term investment, just because the value temporarily dips as the market corrects doesn’t mean it’ll stay that way. The key is to keep up payments any way you can until prices rise once again.
Ben Ong is a mortgage broker at Mortgage Choice, you can contact him here.