This post examines two scenarios. The first is relatively benign. The second is disastrous
Prime Minister Scott Morrison has proposed that first-time home buyers should be able to borrow up to $50,000 towards a deposit on their first home. The loan, plus the capital gain, would be repaid back into the superannuation fund when the house is sold.
There are a lot of variables involved in this transaction: the rate of capital gain on the house, the rate of capital gains superannuation fund, how long you own the first house, the difference between the capital gain on the house and superannuation fund. These are all questions with no answers because they deal with predicting the future and as the famous physicist Niels Bohr said “Prediction is very difficult, especially if it’s about the future!”
But here goes.
This simple model looks at the implications of this proposal using the System Dynamics modelling package Stella which is specifically designed to capture feedback effects between interacting systems, in this case the superannuation system and the housing sector.
In the interests of simplicity there are a number of assumptions built into this model.
The borrower, let’s call her Elizabeth, will earn $60,000 for her working life of 45 years. It goes but not much. Much as wages have done for quite a while. This means the numbers are understandable in todays prices.
Elizabeth will pay 9% of that into an industry super fund and will earn a compound interest rate of 8%.
Elizabeth will buy her first house after she has been working for 10 years and borrow $50,000 from super account.
Elizabeth will purchase a house for $750k and borrow $600k from the bank. The house will go up in value at 8% per annum.
Elizabeth will sell her first house after eight years for $1.2m and purchase a second house.
The total repayments to her super account are $100k, twice what she borrowed borrowed. However, this offsets the impact of the withdrawal of the $50,000 from her super account.
While Elizabeth’s superannuation has lagged as result of the withdraw for a home deposit, the repayment very quickly catches up her superannuation.
Elizabeth’s sale of her first house leaves her with $1.1m. She borrows another $1.1 from the bank to purchase her second house which she lives in for the rest of her life.
The impact of the $50k borrowing on the value of the house over the next 20 years is that Elizabeth’s equity will be approximately $680k less than someone who had not borrowed from their super account . But that will only represent 4% of the market value of the house ($17.4m against $16.8m) when she retires.
This case study indicates how PM Scott Morrison’s proposed $50,000 borrowing from superannuation would work on a best case scenario.
There are many scenarios and they will vary according to the value of the property purchased and the rate of return in the stock market where most superannuation funds are invested and the increase in house prices. These two case studies outline the principles and systemic structures that underlie Morrison’s proposal.
Contrary to what most commentators say there will be no major impact on super as long as the borrowing and capital gain is paid back. The long-term impact, and it will be slight, will be on the capital value of the second home.
But this is a best case scenario.
The worst case scenario is Reg who is like the visitors in respect except one.
His $50,000 is not paid back and Reg stays living in the first home he purchases until his retirement.
The impact on his superannuation is disastrous.
His final superannuation retirement balance will be $1.7m million compared with someone who has not borrowed whose final balance will be $2.4m.
In addition, his initial $50k debt will now have grown to $740k which will presumably have paid out of the $1.7m million in his retirement account leaving the super balance at $1m.
There are a number of variations on this worst-case scenario.
They are all related to how long the borrower delays selling their first home and pays off the initial borrowing.
But any long-term avoidance of repaying the $50k, effectively incurs a compounding penalty interest rate of 8%.
It’s not very good idea when you can borrow money from the bank at 4%.
For many people who are on relatively low incomes, this type of borrowing will have an Increasingly devastating effect on their superannuation balances longer they delay the sale of their first home.
Is this a good policy? The model would suggest is that, at best there is a slight negative effect. At worst it is disastrous.
However, it provides a big proportion of the deposit first home owners need to provide. This will help more first home buyers into the market. However, the effects of this are beyond the scope of this model.