What happens next?

It’s Easter, 2020 as I write this, and most of us are home. Close to two million people have been infected with Covid-19, and more than 100,000 have tragically passed away. It’s hard to see when things will go back to ‘normal’. It looks like Australia’s borders will be closed until at least the end of the year. Every media source I look at talks about how hard these things are to predict.

Yet many of us are asking ‘What happens next?’

While none of us can say how long this pandemic will last, or what the world will look like when it is over, we can take a look at what happens, on an individual level, if homeowners take up the banks’ offer we explored in the previous post.

There, we looked at three different scenarios: 1) paying principal and interest (P&I) like usual, 2) paying interest only and 3) the so-called ‘pause’. And we saw how ‘pausing’ your home loan can actually end up a lot more like pressing ‘rewind’.

But how substantial of a ‘rewind’ is $6,246, like we saw in the previous post? It doesn’t sound like a huge amount, in the scheme of things – not when we’re talking about sums of close to half a million dollars (based on a mortgage of $400,000). But the long-term impact can be enormous.

The long-term impact

Let’s take a look at what happens after six months, comparing those three scenarios.

Scenario 1: Principal and Interest

If you paid P&I throughout the six months, no adjustment is necessary. You keep paying $1,918 per month and eventually your loan will be paid off in full, after shelling out $174,315 in interest. (Yes, I know this is a huge amount, but without making extra repayments, every loan looks like this).

Scenario 2: Interest Only

If, for six months, you paid interest only, after switching back to P&I payments, you’ll have to up your payments by approximately $30 per month for the term of the loan to get back on track.

Scenario 3: The So-Called ‘Pause’

But, if you hit the so-called ‘pause’ button, depending on your bank’s rules, after switching back to P&I, you’ll probably find your payments go up to around $1,975 per month, in order to ensure you pay off the loan on time. That’s $57 more per month than you were paying to begin with.

This is where it gets really scary though: Fast forward another six months into the future, and you’ll still owe more on your home loan than you did when you hit what was supposed to be the ‘pause’ button a year earlier.

Here’s how:

You exit the six month ‘pause’ with an outstanding debt of $406,240, as outlined in the previous post.

Now, instead of owing the bank $1,033 per month in interest as you did in month 1, you owe $1,049 in month 7.

Once you’ve made your month 7 payment, your mortgage is reduced – but only by $925, to $405,315.

The following month, your interest owing reduces a little, to $1,047, thanks to the dent you were able to make in the amount owing last month. But it’s still more interest than you were originally paying. And progress is slow. This month, you reduce your total debt to $404,387.

And so on it goes.

By month 12, assuming you don’t make any extra payments (which would be fairly challenging, considering you’re already having to fork our more for your mortgage payments than you were when you hit ‘pause’) you’ll still owe $400,651.

Yes. Another six months have passed – that’s 12 months from the moment you hit the ‘pause’ button – and you still owe $651 more than you did when you hit that button that was supposed to help you out. The one that was meant to pause things for you in a crisis, and give you a chance to tread water for a while.

All you have done, in this subsequent six months, is try and pay off the interest that the bank charged you during the previous six months.

And you still haven’t even cleared that debt.

The ‘pause’ button banks are offering is helping themselves more than it is helping customers.

Customers who make use of this option may well find that they come out of the so-called ‘holiday’ period worse off. They will owe more money than they did before, and they’ll have to make higher repayments in order to get back on track.

And what of the banks?

Make no mistake, it is not in the banks’ interest for the housing market to collapse, especially when the rest of the capitalist economy crumbles around us, with the dollar plummeting, the stock market crashing, and even gold and oil losing value.

But it is in the banks’ interest to charge struggling home and business owners thousands of dollars extra in interest, which is what this so-called pause really amounts to.

If that’s what playing on ‘Team Australia’ means, it’s not a team I want to be part of.

‘Pausing’ isn’t the end of the story

All of the above assumes that the interest debt is the only debt people who have lost their jobs in this crisis will be accruing.

But the reality is likely to be much worse. People who lose their jobs often struggle to access welfare services. Especially when they’re overloaded. And sometimes claimants are forced to wait out minimum periods, or processing time.

Even more alarmingly, the amount of support on offer from the Australian Government – while double what JobSeekers received in the past – is still far below what most middle-class families regularly spend. This means it’s likely that many people may turn to personal loans and credit cards to get by.

Especially when they’re handed out with many mortgages.

Making it very possible that instead of owing $406,240 at the end of six months, you might owe $420,000 or more, once you consolidate other debts racked up during a period of reduced or no income.

Here’s how:

The average Australian household spends $6,175 per month. Around 20% of this goes towards housing, of which the greatest chunk is mortgage or rent (rates, insurance, repairs and maintenance are also included in this figure). So let’s call it around $5,000 of other spending.

Even if you were to reduce your expenses by half – which would be quite ambitious for many families – or even if you rely on government assistance to pay for half – you could still rack up a debt of $15,000 in a six-month period of unemployment.

Rolling all of this debt together, at the end of the six months, you’d owe $421,240.

Meaning you’d have to up your regular monthly payments of $1,918 not to $1,975 to get back on track, but to $2,018.

That’s $100 extra you’ll have to find every month for the next 25 years.

Assuming the bank is happy to let you roll even more debt into your existing loan.

And they may not be.

Because there is another, even scarier possibility we haven’t looked at yet.

We haven’t considered what your home is worth.

Home equity, and going underwater

Let’s rewind a bit. Back to the beginning.

Let’s say you purchased a home worth $520,000 (pretty average for places like Perth or Brisbane, slightly expensive for Hobart or Adelaide, and almost obscenely cheap for Sydney or Melbourne).

You’re not a risky borrower. You’ve saved up. You’ve bought a solid home with a deposit of $105,000. That is, more than 20%, so the bank doesn’t charge you for Lender’s Mortgage Insurance.

A good beginning…

Even more impressive, you’re super responsible. You saved up enough to cover all the associated additional fees and charges that come along – stamp duty, insurances, moving fees, conveyancing, inspections, and so on.

So, after paying your deposit, and handling everything else, your borrowing comes to $415,000.

Not only do you pay your mortgage on time each month, but you make an extra payment of $100 each and every time, too.

…doesn’t always mean a good middle

By the time you’re halfway through the second year of your mortgage, your owe around $400,000, and you’re a month ahead in your payments. You’re on track to pay off your mortgage more than a year early, and you’re hoping that, once your pay rise comes through next month, you’ll be able to up your extra payments even further, to $500 a month – meaning you’ll have your mortgage done and dusted six years sooner than the bank predicts.

What’s more, your house has gone up in value, too. It’s now valued at $525,000 (approximately the sort of growth seen in some of our capital cities). Which means you have $125,000 in equity.

But then, crisis strikes. Like millions of others around the world, you lose your job. The month you were ahead will quickly go by, and your next payment will be due.

You hit that ‘pause’ button.

Six months later, when, hopefully, the dust has settled, and you have a new job, you now owe $421,240.

That’s taken away a good chunk of your equity. You now only own $103,760 of your home. Less than you initially put down for your deposit.

And that’s assuming your home is still worth the $525,000 it was six months ago, when the crisis hit.

Is that realistic?

I’m afraid it might not be.

With overseas purchasers not allowed in to buy new buildings, there will be more options for domestic buyers, of whom there will likely be far fewer, anyway, since unemployment won’t just have affected you. There may be 10% or more of the population out of work by this stage. And as more people experience financial distress, there will be more people looking to sell.

There is already some discussion of greater protection for tenants which would mean landlords would have fewer, or even no powers, to evict tenants who can no longer pay their rent.

Remain Indoors

Undoubtedly, something needs to be done to help those most vulnerable in our society, especially when the war we are fighting is a viral one. The solution is for everyone to shelter in place. To stay at home. To, as Mitchell and Webb put it, “Remain Indoors“. But economically, landlords cannot be expected to pick up the full tab. The vast majority of property investors aren’t wealthy fat cats with multiple properties under their belt. As we’ll detail in a future post, we’re not talking about the ‘richest of the rich’ here. Many investors are mortgaged to the hilt.

Regardless of what legal settings may be put in place, if there are no rents coming in, or landlords have to reduce rents so low they can’t afford to pay the maintenance and management fees, let alone the interest on their properties, there’s every chance they’ll want to sell up too.

Supply and demand

In other words, lots of people will want to access cash, and few people will have any to spend.

And as we all know, when there’s a lot of supply, and very little demand, prices generally plummet.

We’re seeing unprecedented losses across pretty much every asset class, with some suggesting share markets around the world may halve in value – or worse.

Housing is not immune to this.

Chief economist at AMP Capital, Dr. Shane Oliver, has predicted that a 10% unemployment rate due to the impact of coronavirus could result in a 20% drop in housing prices in Sydney and Melbourne.

What would that look like on a home that was worth $525,000?

A drop of 20% is a drop of $105,000.

Meaning that your home’s value may decrease to just $420,000.

That’s $100,000 less than you paid for it.

And worse, it’s less than your current total debt.

A bank may not allow you to roll additional debt into your mortgage under such circumstances – meaning you’d be stuck paying the higher interest rates on a personal loan and/or credit cards.

Even if it did, perhaps before the property price fall, you’d still have what is technically known as an ‘underwater mortgage’ – one where the principal you owe is higher than the free-market value of the home. This is what happened to so many, in the US especially, during the global financial crisis (GFC).

Scary numbers

There are a lot of terrifying numbers floating around at the moment. From mortality rates to mortgage defaults, from infection rates to interest rates. It can all feel a bit surreal. Like we’re watching a movie. But the predictions we’re hearing aren’t wildly unrealistic.

During the GFC, even though Australia managed to escape a recession, the median house price in Sydney dropped from $540,000 to $448,000 – that’s a drop of $92,000. Or close to 20%.

During the Great Depression, the five year unemployment average between 1930-1934 was 23.4%, with a peak of approximately 30% in 1932. So a rise in unemployment to 10 or 11% is quite likely a conservative estimate.

My aim in sharing this scenario isn’t to terrify you.

The point is to demonstrate how interwoven our economy is, how carefully it must be managed, and how we need to take care of everyone. To demonstrate that crises like pandemics can affect everyone – including ‘average’ people, from all stages and walks of life.

Including those who have done the ‘right’ thing.

Young people

who’ve just moved out of home and rented their first property.

They’ve done all the right things – got renters’ insurance, pay their bills on time, including their rent. Pass every inspection with flying colours.

But they can’t continue to do so if they have no income coming in. And although there is government assistance out there, it may not cover their existing costs – if they can even access it. We’re seeing lines stretching around blocks, at a time when people should be social distancing in order to save lives. All because the government has, for decades, underfunded and understaffed Centrelink, apparently in an attempt to make obtaining welfare as difficult as possible. And we’re seeing many people – including hardworking international students and holiday visa holders – slip through the cracks.

More established individuals and couples…

– the ‘mums and dads’ as they’re often called – who’ve saved their whole lives to buy an investment property so that they’ll have an income in their retirement.

For many of them, superannuation was introduced too late to help them save enough. So they tried to be responsible, investing in bricks and mortar, so they wouldn’t be a burden on the next generation – either their own children, or the taxpaying public. Who, when their renters can no longer pay, no longer have an income.

And in the middle, we see families…

who’ve saved up a solid deposit, made extra payments on their loans, and done everything by the book.

And gratefully accept the ‘opportunity’ given to them by the banks, and trumpeted by the treasurer, only to find themselves in a deeper financial hole at the end of their loan holiday than they were when they started.

Who is to blame?

As this post demonstrates, even those who have tried their best to do everything right can be caught out by the bad timing of an unpredictable, horrible event.

Wherever you find yourself in this mess, it’s important NOT to blame yourself. While there are steps we can all take to try and mitigate the sorts of difficulties life sometimes throws our way, we cannot help the timing of these catastrophic events.

But no matter how bad things may get for any of us economically, the most important thing is the health of ourselves, our loved ones, and indeed, our fellow human beings. Anything else, we can repair.

What can I do next?

The most important thing you can do at the moment is to HOLD ON.

Hang in there.

Remember, as I said in my last post, that we are all in this together.

You are not alone. And although times are tough now, I have every faith that we will come out the other side a stronger, more compassionate world than we were going in…

If you are a long-term reader of Enrichmentality, you’ll know that there is a lot we can do as individuals to improve our finances, even in the face of hardship. Here are some ideas to get you started:

Mega list of downloadable resources
Mortgage-related topics:
Work out which debt to pay off first
Understand refinancing
Make reducing debt fun
Deal with your finances, without sticking your head in the sand or becoming obsessed
Groceries and utilities:
Slash your spending in every category
Start menu planning
Shop for groceries less, and spend less
More shopping strategies
Work out what is a need vs. a want
Grow your own food, even if you don’t have a garden
Save on utilities
And some specifically COVID-19 related articles:
How can I make my own face mask (and why should I)?
How can I prepare with just $30

If you need someone to talk to, 24 hours a day, Lifeline Australia (13 11 14) is there to help, throughout the coronavirus crisis. And if you need specifically debt-related assistance, the government has a National Debt Hotline you can make a free call to (1800 007 007). Find out more about financial counselling on the Money Smart website.

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