Brokers Ride The Wave

Mortgage brokers, after several years in the doldrums, have an opportunity for growth.

DFA tracks the flow of new mortgages including the channel of origination in its market model. Third Party (aka broker) originated loans are on the rise, both in absolute terms as volumes increase, and in relative share terms compared with bank originated loans.  The first chart shows the trend of loans via brokers, and a projection, based on anticipated volumes. Note this is based on the number of loans approved, not their value. It covers all lenders, including the non-banks who have a growing share of business, and who are very reliant on brokers.

Broker-Share-DFAAPRA provides data on this also, but looks only at ADI’s (so does not include non-banks) and shows the value of loans approved, not volume.

Broker-Share-APRAWe also model the commission flows from new loans, and following recent improvements in commission rates from some lenders, plus the stronger volumes, commissions are up. The chart below shows the relative commissions paid, using the peak in 2007, when the first time buyers were active, and commissions were more generous, as the baseline. It shows that whilst commissions are up compared with recent months, they are not back to their 2007 levels. Overall the number of mortgage brokers in the industry have fallen in recent years.

Broker-CommissionThe final picture overlays the DFA segmentation broker preference analysis from our household survey.  Refinancers, and Investors are the most likely to use a broker, and with down-traders are likely to transact at the moment. First time buyers, whilst likely to use a broker, are frozen out of the market because of high prices. So brokers who want to grow their business will need to tailor their targeting, and lenders should consider changing commission levels for different types of business.

Broker-SegmentBoth brokers and lenders are under an obligation now to ensure that the loan is “not unsuitable” (thanks to ASIC), and the “not unsuitable” criteria may well vary by segment. But the bottom line is brokers, after several years in the doldrums, have an opportunity for growth now.

Down-Traders are on the Move Too

Continuing the discussion about the findings from our Household Survey, we turn to the Down-Traders. Typically they are older, often baby-boomers looking to sell their current property, at a hansom capital gain and buying something smaller, paying off their mortgage along the way, and laying the foundations for their retirement income. They may even purchase an investment property with some of the sale proceeds.

Our survey identified that more than 1.3 million households are considering selling and buying a smaller property. Of these 71% are considering an Owner Occupied Property, and 29% an Investment Property. Of these 677,000 currently have no mortgage and own the property outright. Around 43% of these households expect house prices to rise over the next year, whilst 45% expect to transact within 12 months, 14% will consider using a mortgage broker and 16% will need to borrow more. Households will transact to facilitate increased convenience (27%), to release capital for retirement (24%), because of unemployment (15%) or because of illness or death of a spouse (9%).


What makes this segment so significant is that they are transacting to capitalise on the lift in house prices, but without the need for significant housing finance. This is one of the main reasons why the growth of house prices and the slower growth in credit do not align. It also means that low interest rates is not a direct catalyst for this group.  They are in fact competing with first time buyers and investors for property of very similar type.  It could well be that as Down-Traders are so active, we will see an over supply of larger more expensive property and an under supply of smaller houses and units, with differential price inflation to match.

First Time Buyers – The Stressed Class of 2009

When interest rates were high a couple of years back, DFA regularly reported on Mortgage Stress – not the unhelpful “more than 30% of income paying loan repayments”, but a more insightful analysis of the relative income and payments by households. We defined those in stress as households who had more outgoings than income, were cutting back on expenditure, were putting more on credit cards, or worst case were close to default.

Well, the reported story these days is that everything is now fine, because rates were cut to a 50 year low, and so repayments are low. Whilst that may be true for many, our recent household survey indicates a particular problem area amongst First Time Buyers who were persuaded to buy in 2009/10 by the enticing First Owner Grants. As we have commented before, there was a surge in demand, with up to 30% of new loans going to these First Time Buyers, and the side effect was that house prices rose by the amount of the grant.

We looked specifically at these First Time Buyers and discovered that 5 years on, the levels of mortgage stress which exist in this cadre is significantly higher than the average. The chart below shows the level of stress as a count of households, mapped to the number of loans which were written.

FTBStressWe see a normal stressed rate of about 4%, but amongst the class of 2009, its nearer 13%. As you would expect more recent loans have not gone bad yet, as it takes months for mortgage stress to surface.

But the question is, why so much stress in the class on 2009? Our extra questions identified that 60% of the problems came from a combination of rising power bills, other borrowings, rising council rates and rising child care. We also found that only half had a formal budget to track income and spend. Saving was not on the agenda. The fall in mortgage repayments has not been sufficient to offset other rises in the costs of living.

FTBStressCauseHalf the additional borrowing came from credit cards (average is 4.2 cards per household), with the the rest spread across other sources.

FTBStressBorrowThe class of 2009 are fortunate in so far as property prices are rising, so they can always exit the market and raise some cash, but the consequences of poor public policy in 2009 are still been seen in this household group.  If unemployment continues to rise, as expected, then it is this group which are likely to feel the pain first. Meantime they will continue to hunker down and keep discretionary spending really tight. If rates were to rise, then things will get worse.

Up-Traders On The Move

The DFA Household Survey, The Property Imperative used proprietary household segmentation to examine intent in the market. Up-Traders, people who are looking to buy a bigger place, is one important segment active at the moment. Our survey identified about 1.0 million households who are considering buying a larger property. Most (95%) are Owner Occupied. Of these households, 19% are expecting to transact within the next 12 months, whilst 43% of households expect house prices to rise in this period. The main reasons driving these households to transact are, to obtain more space (34%), as a property investment (31%), because of a job move (18%) and for a life-style change (8%). Many of these households will require further finance (68%) and a quarter will consider using a mortgage broker (25%), whilst 38% of these households are actively saving to facilitate a transaction.

Many of these Up-traders will be buying property from the Down-Traders, and this interchange of property after several years of stagnation is one of the reasons why the market is hot. However, we did note a mismatch between the expectations of these two groups, with Up-Traders much more bullish about the market. This may lead to some interesting price negotiations!



The Incredible Shrinking Plot

During the DFA household survey we collected data on house prices and plot size. New building plots have been shrinking, and its now not uncommon for a 4 bedroom house to be built on a site under 300m2, whereas older plots were often 6-800m2. So we looked at the average establish house price and by dividing this by the size of the plot calculated the average effective cost per sqm for the house and land on transfer.

In 2001 the average combined plot and land cost was around $750m2, today its over $1,800m2. This is a rate of growth (the red line) much higher than average house prices (the blue line), so today, house purchasers are paying much more for much less.  This is not surprising, as for example in the developing outer suburbs of Perth, existing land parcels are regularly being subdivided into 3 plots.

Of course there are other factors to consider. Over the period 1993-94 to 2008-09, the average size of a new house in Australia increased from 188.7m2 to 245.3m2 according to the Australian Bureau of Statistics.  Construction costs have grown, today for a four bedroom house they range from $1,570 to $2,250 per sqm depending on specification.

Nevertheless, this growth per sqm trend in not widely recognized. Real inflation in the housing sector is even greater than house price growth may suggest! I should add I used Sydney data for this analysis.


Property Holders Bullish About Property Prices

More from the recently published report, The Property Imperative. Holders are defined as households with no plans to move or refinance. There are more than 1.0 million households in this segment, with 81% Owner Occupied and 19% Investment. 437,000 of these properties are owned outright and are mortgage free. Of these households 90% expect house prices to rise in the next year, but only 2% would consider using a mortgage broker because they are by definition not intending to transact in the next year.


First Time Buyer Incentives Are Bad News

In the DFA Property Imperative Report we highlighted the fact that First Time Buyers (FTB) are having difficulty buying in some markets, especially NSW and VIC. In Tasmania, where FTB are still active, the Government there recently lifted the FTB grant to $30,000 (close to 10% of the average first home in TAS). We have looked at what happened when Labor lifted the grant as part of the post GFC stimulus, and the results are clear. There was a spike in new FTB sales, (close to 30% of all new loans at its peak) as buyers accelerated their plans to buy and take advantage of the deal. But prices lifted by the amount of the grant, or more, and there was no adjustment back after. First Time Buyer transactions had a small trickle down effect on households looking to trade-up, and this flowed into price increases up the market. The increase in transactions flowed stamp duty revenue to State Governments. We also know that about 30% of those FTB who entered leveraging the incentive scheme are still in financial difficulty, thanks to rising power, water and rates, and this despite a current record low RBA bank rate.

Our net conclusion is that a broad based FTB incentive scheme is bad for the market and for households. Those targeting only new builds are better, but new builds only make up a small proportion of the total, and these properties are often on the outskirts of Cities without good transport links to work places. The better option would be to take away barriers which exist on the supply side of property, especially on brown field sites. We need another 250-300,000 residential units nationally to meet current demand. Supply side strategies could lower prices in the process. However, as the most significant barriers relate to State Government charges for new development, there would be resistance to turning off this revenue supply anytime soon. I fear more Governments will look to expand FTB incentives on existing property and take the cash generated from stamp duty and development charges, rather than adopt a more strategic approach. This will lift property prices even higher.


High LVR Loans Example

I received quite a lot of inquiries about the DFA Property Report, and the rise in high LVR Loans, as reported in the SMH and ABC TV. Several people asked about the type of loans which are available. Well, I went to one well known lender and found the following:

  • Depending on your circumstances, there maybe no need to save a deposit. Where the LVR exceeds 85% evidence of 5% genuine savings is required.
  • Available to fund renovations or home improvements
  • You could borrow up to 120% of the full purchase price plus upfront costs (must include home improvements and debt consolidation or borrow up to 110% if including either home improvements or debt consolidation or borrow up to 105% if only borrowing full purchase price plus upfront costs, or if your total loan LVR is greater than 90%)
  • Could save yourself thousands on lender’s mortgage insurance costs.
  • Available on home loans for owner occupier plus investment purposes (excludes Line of Credit and Self-employed Low Doc loans). Can be used for Construction purposes where a fixed price contract and plans are supplied and where no debt consolidation is required.

This is being offered on the back of a guarantee of up to 125% of the property value. Its advertised as being ideal for First Time Buyers. Other lenders are also offering high 90% loans.

A Quarter of Refinancers Expected To Transact Within 12 Months

Further findings from the Property Imperative report, now available from DFA.

Households who are restructuring their finances, but not moving house are Refinancers. There are around 677.000 such households considering a refinance of an existing loan, of which 79% relate to an Owner Occupied property and 21% to an Investment Property. To assist in the refinance, 67% of households will consider using a mortgage broker. Households are looking to refinance for a number of reasons, including reducing monthly repayments (35%), to lock in a fixed rate (19%), because of a loan rollover (16%), in reaction to poor lender service (11%), for a better fixed rate (9%) or to facilitate a capital withdrawal (8%). In the next 12 months, 26% of these households are likely to transact, whilst 84% expect house prices ti rise in the next 12 months.


Are Higher LVRs Always A Problem?

Data from the recently released Property Imperative Survey shows that on average Loan to Value Ratios (LVRs) have risen recently. The ratio between the value of the property and the size of the loan is important because borrowers and lenders are protected by the buffer should property prices fall, thus avoiding negative equity, and losses, in the event of a sale.

Negative equity is only crystallized when a property is sold, so provided the borrower can continue to make repayments day-to-day its not really an issue although it may stop the borrowers moving so readily. Banks do not generally mark to market on a continuous basis, so unless overall values started to fall, it might not be a problem. Its a question of what happens should the market fall from its highs. If there were to be a step drop, like in the US, then buyers and banks might be in difficulty, which is why regulators worry about lending standards.

But, that apart (and of course house prices can fall) the mix between types of borrowers is changing, with a greater share of Investors looking for tax efficient borrowing, and first time buyers borrowing more, whereas down traders will be cashed up and will need to borrow less, if at all.  Thus a lift in average LVRs can be simply a function of a mix shift, not a significant change in underwriting policy. Averages are, on average not always helpful!