How will the Australian property market look in 2010? If you believe the property experts such as Phil Kelly from OzInvest, then it’s a perfect time to buy property now.

Not just because he thinks you may want a place to live, but because you’ll be doing your bit for your country.

He explains the role, “tax benefits for negative gearing plays in easing the current housing shortage and how it can help ordinary Australians build wealth for a safe and secure retirement.”

You see, when you build a house you’re actually helping to fix the “chronic” housing shortage. And you thought it was just so you had a nice place to live.

The housing bulls are feeling as strong as ever. Michael Pascoe wrote in The Age recently “House prices NOT tipped to slide.”

But what’s the other side to the rosy picture on property? Could there really be news stories such as the following within the next twelve months:

“Banks have launched action to take 707 properties, worth more than $200 million, in the past three months.”

“Homeowners are being served with repossession orders in some cases when they are only $2000 or just a few weeks behind in repayments.”

“HALF of all claims involved owners who had their homes for less than two years, and two out of 10 involved borrowers who had owned their home for less than 12 months.”

“BORROWERS who don’t pay on time are being charged penalty interest, double the original rate. Some are being charged 20 per cent on loans and default rates of up to 40 per cent.”

“The average loan being called in was $244,000, on which repayments have risen by $460 a month…”

“A loan of this size, taken out at today’s average rate of 8.95 per cent, would cost an extra $138,000 in interest over 25 years…”

“Homeowners have told of repayments rising above their income and financial stress leading to ruined relationships.”

“Former Croydon homeowner Rodney said he was just $3000 behind on his mortgage when he found the locks had been changed by his bank.”

Is it really that far-fetched to picture mortgage interest rates climbing to nearly 9% compared with the 5.5% or so today? Maybe it won’t be next year, maybe it will be the year after, or the year after that.

Well, the quotes above are taken from Melbourne’s Herald Sun in February 2008. That of course was near the end of the Reserve Bank of Australia’s period of increasing interest rates.

When interest rates were at the previous record low, mortgage rates were a similar level to today’s rates. Then from mid 2002 until September last year interest rates climbed until reaching a peak of 7.25%.

But even between mid 2002 and the end of 2003, interest rates climbed by 0.75%.

Can it be guaranteed that interest rates won’t follow a similar path by the end of next year? No, of course it can’t. And if you look at how the bond market is trying to push rates higher even as the RBA is keeping them artificially low, it is obvious that mortgage rates are set to rise.

I’ve printed the Aussie yield curve again below. Even in the last week, rates at the short end (3 months) have increased by 0.05%.

But look again at the average loan size quoted in the Herald Sun article – $244,000. That’s significantly below the average loan commitment being made by first home buyers now. According to the recent Australian Bureau of Statistics (ABS) numbers “the average loan size for first home buyers fell $2,500 [from the previous period] to $283,400.”

Still, that’s over 15% higher than the average loan default during 2007/2008.

There can be no doubt at all that current actions in the Australian housing market are helping to prop up house prices. The danger at the moment is to think that either the propping-up has ended or that the worst is over.

Both assumptions are wrong.

We’ve even put our reputation on it by tipping a real estate investment trust in Australian Small Cap Investigator on the assumption that misplaced bullish sentiment on property will last at least through to the end of this year.

And don’t forget, not only has the Federal government extended the first home buyers grant, but State governments have raised the bets too. First home buyers in regional Victoria will qualify for $36,000 to put towards buying a home between July and September.

And now second home buyers in New South Wales will get a stamp duty reduction until the end of this year.

Eventually, as with all bubbles, the inflow of funds cannot be maintained, and the crash occurs – usually when investors think the worst is over!

To put it in context, a $283,400 home loan today at 5.74% means a monthly repayment of $1,782. Should the rates increase to 8.95% the repayments go up to $2,369 per month, or nearly $600 extra per month.

That’s about an extra $850 per month of before tax income, or not surprisingly, $10,200 per year of before tax income, which will eat up an extra 17% of an average Australian’s salary – assuming they are in a single earning household.

So, even if we believe that people will do all they can to keep hold of their home rather than allow it to be repossessed, rising interest rates will clearly have an impact on the economy.

Hence your editor’s concern in Tuesday’s Money Morning about businesses being encouraged to spend up on capital goods now when chances are in twelve to eighteen months time the investment in capital goods will have been wasted as the consumer is unable to purchase the goods being produced.

What does that tell you about the outlook for the economy going into next year?

Other Stuff on the Markets

The S&P/ASX200 0.24% yesterday, while on Wall Street with the Dow Jones Industrial Average slipped 23 points. In Europe the FTSE100 and CAC40 gained 1.18% and 2.18% respectively.

The price of gold in Australian dollars is trading at $1,168.38, while in US Dollars it trading at $931.30.

The Aussie dollar steadied versus the US dollar and Japanese Yen, trading at USD$0.7963, and JPY76.23.

Crude oil closed at USD$68.27.

For the biggest movers on the market yesterday click here…

And today on the economic calendar we have in the US, GDP, initial jobless claims and personal consumption numbers.

Cheers.
Kris.