3 ways to shrink your mortgage + The 'two sided' risk to the economy

Hi everyone, happy Friday.

A fairly quiet week on the local economic front, although the world’s most powerful banker, Fed Chairman Jerome Powell, did speak to a US Senate Committee this week - which I’ll cover shortly.

This morning the latest CPI figure from the US was released and inflation fell in June. The rate of growth didn’t slow - it went down 0.1 per cent (markets were expecting a 0.1 per cent increase). Markets are now predicting that the Federal Reserve will cut US interest rates at its September meeting.

The annual US inflation rate to the end of June dropped to 3 per cent.

A rate cut in the US has implications for Australia as it will push up the value of the Aussie dollar, which makes imports (and overseas holidays) cheaper but exports more expensive. That’s a big consideration for our Reserve Bank.

Plus, as I will talk about soon, two of the main drivers of our inflation - rents and construction costs - are starting to slow. Hopefully we’ll see that reflected in a better CPI figure the week after next.

Okay, let’s get stuck into it. In this newsletter:

• The crippling rise in rents is starting to slow, which is good news for inflation … and tenants.

• The rise in property construction costs is starting to slow.

• The ‘two-sided risk’ to the economy and the implications for interest rates.

• Three fast ways to shrink your mortgage and pay it back faster.

• Do you need lenders mortgage insurance? The pros and cons.

• Is it time to get back into real estate shares? 

First up, as we battle the cost-of-living crisis, a slowing economy and high interest rates, a bit of perspective from the 2024 UBS Global Wealth Report released this week:

The wealth of the average Australian grew by nearly 10 per cent in 2023, which was nearly twice the average growth rate of the other 56 countries in the study. That made average Australians the second wealthiest in the world, behind Luxembourg.

Australian’s median wealth came in at $US261,805 ($A388,192) and we have 1.9 million US-dollar millionaires whose total wealth is $US5.4 trillion ($A8 trillion).

Obviously, the foundation of the wealth of Australians is a combination of the surging value of our homes and superannuation. But when you add in the inheritances from the intergenerational wealth transfer, UBS reckons the number of Aussie millionaires will grow another 21 per cent to 2.3 million by 2028.

Great news for inflation … and renters

One of the major drivers of inflation has been soaring rents, along with construction costs. According to property research group CoreLogic, those rising rents are starting to slow, particularly when it comes to home units.

Rents are still going up but have slowed considerably. Annual growth in rent values slowed to 8.2 per cent and in the month of June slowed to 0.4 per cent,  the lowest rate of monthly growth rate since September last year. 

In the past year the growth rate in capital city unit rents has halved from 15.1 per cent to 7.6 per cent, with the biggest slowdowns in major capitals Sydney, Melbourne and Brisbane.

In Sydney, the annual rate of growth for unit rents fell by a whopping 10 per cent to 7.1 per cent,  Melbourne unit rent growth dropped to 7.5 per cent and in Brisbane to 8.5 per cent.

For Sydney and Melbourne unit markets, the growth rate remains well above historic averages, which was respectively 2.7 per cent and 2.6 per cent throughout the 2010s.

In contrast, annual growth in house rents has increased slightly and regional rents have also re-accelerated. This suggests rental demand may also be pivoting away from capital city unit rentals and towards capital city houses as well as the regional market.

Construction costs are slowing as well

That other inflation fiend - residential construction costs - looks to have stabilised and is growing at the slowest annual rate in 22 years.

According to CoreLogic’s Cordell Construction Cost Index, construction costs for the last financial year increased by 2.6 per cent, the smallest annual rise since 2002 and below the inflation rate.

That’s great news but costs are still growing and not falling. Building and renovating costs are a whopping 30 per cent more expensive than pre-COVID.

But according to CoreLogic and building group Cordell, there are some signs of price falls starting to appear. For example, timbers and metal products. These are significant in residential construction and used for framing, trusses, floors, cladding and roofing.

Supply chain issues, which plagued the industry throughout COVID have largely been resolved but labour costs, for example, remain elevated and contribute significantly to any residential project.

The ‘two-sided risk’ to the economy … and the Central Bank dilemma

History tells us that the last economic indicator to shift in a downturn is employment. My fear is that we are at that tipping point now.

And history tells us that when employment turns, it does so quickly and surprises everyone.

The boss of the US Federal Reserve, Jerome Powell, made the point in his Senate testimony this week that while the Fed still remains vigilant about inflation, his fear is that the economy and employment is “cooling” - fast. He talked about the ‘two-sided’ risk to the economy of inflation and a deteriorating jobs market.

I reckon Reserve Bank Governor, Michele Bullock, is on exactly the same page as the Fed Chairman. Powell made the point to the US Senate Committee that the timing of rate cuts is critical. Leaving it too long runs the risk of a sharp spike in unemployment, which will be hard to turn around.

The Reserve Bank’s charter is to fight inflation and preserve full employment. While we’ve all focussed on interest rates fighting inflation, we’ve ignored the impact on employment. 

I think employment is very much on the mind of the RBA and is why I think they’ll be reluctant to increase interest rates at their next board meeting, despite the surprise rise in the May CPI figure. 

The all-important June quarter CPI is released before that next RBA board meeting and will obviously play a role in their decision as well. The worry about employment will certainly have to be balanced against any CPI result. 

Australia’s unemployment rate is a very low 4 per cent. But the official figures just don’t seem to match reality. 

Business insolvency figures are spiking toward new records. The media seems to have a daily focus on prominent restaurants/cafes/bakeries that are closing. I walk through a major shopping centre on my way from the office to the gym and am amazed at how many shops have closed and sit dark with “for lease” signs plastered across the windows. I’ve also been supporting a small online cocktail business since they started three years ago. This morning I received an email that they’re closing.

Then at the big end of town Telstra, the big banks, mining companies and media empires have been announcing mass redundancies.

That 4 per cent unemployment rate just doesn’t seem believable. Particularly when we’ve soaked up record levels of migration over the last year.

It’s important to understand there is always a gap between being retrenched and being able to apply for JobSeeker (unemployment benefits) and be included in the official statistics. 

First of all, there’s the ‘liquid assets’ waiting period which applies if you and your partner have enough money to live on for a while, including bank accounts, financial investments and term deposits. Depending on how much money you have, the waiting period for eligibility for JobSeeker could vary from one to 13 weeks. 

Then there’s the ‘income maintenance’ period which applies if you left or lost your job and your employer paid you for sick leave, annual leave, termination of employment or a redundancy payment. You may not receive any income support payment for this period, or you may receive a reduced rate. 

Given these waiting periods you get a foreboding sense that there is a huge bulge of unemployed coming down the social security pipeline and about to hit the official numbers.

There is no doubt the economy has been slowing but many of the economic indicators have been buoyed by the 500,000 new customers which have settled here through migration and international students. Unfortunately, these new arrivals have become convenient political pawns, scapegoats for the housing crisis and the surge in property values and rents.

As a result, the federal government has vowed to cut migrant and international student numbers. The reality is that the housing and rental crisis has been caused by a lack of new homes being built because of rising construction costs, building approvals at 10-year lows and a lack of new land being released. 

This has meant Australians have been asset rich but cash poor as they fight rising interest rates, the cost of living crisis and the economic slowdown. They’ve coped so far because they’ve been running down their savings, their biggest asset (home) has been rising in value and they’ve had a job.

But that is all set to change as savings have run out and retrenchments are starting to pick up pace.

There are some worrying signs for the employment market. According to the huge employment platform, SEEK, in June the number of jobs being advertised dropped 1.7 per cent and were down 17.1 per cent compared to the same month last year. The number of people applying for each vacant job rose by 3 per cent in June.

The job market is deteriorating quickly and this is likely to force the RBA to rethink any rate rise in August and, depending how quickly the unemployment rate rises, could even bring forward interest rate cuts.

3 fast ways to shrink your mortgage - and beat potential rate hikes

How would another rate hike impact your household budget? A single 0.25 per cent increase could add around $123 to monthly repayments on a $750,000 mortgage. That could be $1,400 more over the course of a year if rates don’t budge thereafter. 

So how can you put yourself in a better position to ride out a possible hike and improve your budget for the long term? 

Here are my top three mortgage hacks to pay off your loan faster and potentially soften the blow of future hikes over time.  

1. Switch to fortnightly repayments

By making a small change to their repayments, homeowners could save tens of thousands of dollars and pay off their loans faster.

Compare The Market crunched the numbers and found a person with a $600,000 loan could save over $160,000 in interest over the life of the loan (and cut down their loan term by over five years) if they were to switch to fortnightly payments instead of monthly.

You’re not just paying slightly more, you’re paying it back early. 

But you’ll need to tell your bank that you want to pay half of your monthly repayments fortnightly. Because if you simply switch to a fortnightly repayment plan, this could be a smaller payment amount, and then this hack might not work for you.

For example, if your monthly payments are $3,694 you will want to pay $1,847 per fortnight. Because of the calendar, this means you’ll be paying an extra $3,694 each year, which will cut down your principal and interest owed to the bank.

2. Put savings into an offset account or make extra repayments

If you keep a decent balance, an offset account has the potential to help you save money in loan interest and pay off your mortgage sooner.

It’s also a great incentive to save. And unlike regular savings accounts, you won’t pay tax on the interest you offset.

Having just $25,000 in an offset account for a $500,000 loan with an interest rate of 6.19 per cent could reduce your loan term by three years and 1 month and save more than $110,000 in interest over the life of the loan.

If you want to shrink your loan size immediately, you may consider just making extra repayments. Improving your LVR (Loan to Value) may help you to access more competitive rates. 

3. Refinance to a better rate and adjust your loan term

Borrowers shouldn’t wait for a cut in the cash rate. A Compare The Market analysis of some of the rates available from the Big Four showed the average difference between front-book (new customer) and back-book (existing customer) rates is 1.96 per cent.

Therefore, a person with an owner-occupier $750,000 loan could be saving $1,008 a month if they switch from a rate of 8.54 per cent to 6.58 per cent.

I’d encourage people to be sceptical of their home loan interest rate and to compare it against what their lender and other lenders are offering new customers. If you’ve been with your lender for more than a couple years, there’s a good chance you’ve fallen on a higher ‘back book’ rate and are paying more than you need to be.

If you can, adjust your loan term to reflect your mortgage journey status and repayment goals. If you choose to retain a 30-year loan, your monthly repayments will be smaller, but you will end up paying much more in interest over time. 

Should you pay LMI or keep saving for a 20% deposit?

Saving for a deposit can be a major challenge for aspiring homebuyers - a 20 per cent contribution is now more than $230,000 for a median dwelling in Sydney and $168,000 for a median dwelling in Brisbane. 

Paying extra for Lenders Mortgage Insurance (LMI) may be the only option to overcome the hurdle for buyers without access to the ‘Bank of Mum and Dad’. 

Some lenders will allow you to apply for a home loan with a deposit as low as 5 per cent but usually you will have to cough up more for Lenders Mortgage Insurance - a fee that pays for the insurance to reduce the additional risk. 

Depending on your loan size and deposit, that could add tens of thousands of dollars to your loan, so it’s not a commitment that should be taken lightly. 

But is LMI still a dirty word? If owning a home is part of your long-term plan, and you are confident you can meet the repayments, you could still reap the rewards in equity if the value of the property increases enough before you decide to sell it.

With property prices climbing tens of thousands of dollars in some parts of the country, a lot of buyers feel that they are falling behind while trying to save that 20 per cent deposit. Those people might weigh up the extra cost of LMI and find it might be worth it.

Just remember that when LMI is added to your mortgage, you’ll also pay more in interest too - and that can add thousands on to your repayments over the life of your loan.

The median house and unit value in Australia increased 72 per cent in the decade to 2022, helping to put hundreds of thousands of property owners on the path to financial freedom.

Ask those borrowers if they regret taking out LMI and they’d probably say it was worth it.

LMI pros

• Get into the market sooner.

• Beat possible property price hikes.

• Benefit earlier from any increases in property values.

LMI cons

• Usually accompanied by a higher interest rate.

• You will have a larger loan.

• Loan repayments may be higher.

LMI can cost several thousand to north of $20,000, depending on the size of your deposit and how much you’re borrowing.

Some lenders may offer to waive LMI for customers in high-earning professions, such as doctors and lawyers because they are considered to be less risky. 

There are also LMI offers available to select borrowers - some lenders may offer LMI for $1 for eligible homebuyers. NAB is one bank that offers a discounted LMI loan for energy-efficient homes on a base variable rate.

If you don’t have help from the ‘Bank of Mum and Dad’, then incurring LMI might be your helping hand onto the property ladder.

Here are my tips for getting into the market:

Calculate the costs

Your saved deposit will need to cover the various upfront costs associated with buying a house, including stamp duty and conveyancing fees. Use a property-buying cost calculator that can make it easier to budget for your property.

Get a suburb report

Get a suburb report and get to know what houses are selling for in your desired area. If the median is high, check and see if you’re able to get better value for your money a suburb or two out. 

Secure the lowest interest rate

Choose a competitive home loan rate, which can make a big difference when it comes to mortgage affordability. Some experts are forecasting that the RBA will increase interest rates again this year, meaning you’ll want to be on the best possible deal.

Stock Watch: Is it time to get back into Real Estate Investment Trusts?

Macquarie Bank thinks it is ...

Real Estate Investment Trusts (REIT) have been the ugly duckling of the Australian sharemarket post-COVID on the back of rising interest rates and the slow return to the office for many workers. Many of the REITs are trading at a 20-30 per cent discount to the value of their property holdings.

The reason for this is that analysts believe many of the property investments are overvalued and haven’t been revalued to current market conditions. Also, rising interest rates have hit the bottom line of those REITs with high debt levels.

But Macquarie Bank analysts think the time is right to get back into REITs and take advantage of their low valuations. The basis of their decision to overweight their model portfolio into REITs is the view that interest rate cuts are on the way. They are disregarding the prospect of an RBA rate rise.

“With the [US Federal Reserve] expected to cut in September, we would look past the risk of an RBA hike, and are now overweight REITs,” Macquarie Bank concluded in their report.

“We expected a hawkish shift from the RBA, and it has happened. With the shift to slowdown and global banks easing, there is reason to think the RBA will hold so as not to risk pushing the $A up too far.”

Charter Hall and Goodman Group are Macquarie’s favoured REIT’s but they’ve also now added Mirvac.