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“Don't sail out farther than you can row back.” This Danish saying is sound advice for anyone thinking of borrowing to buy a home, particularly now that interest rates are low and house prices are generally rising.
According to a paper1 for the Centre of Policy Development and University of Canberra, Australians have a tendency to be over-confident in our ability to repay loans. We also underestimate the likelihood of things potentially going wrong in our lives.
Have you ever heard yourself or someone else say “I’ll be able to repay my loan, provided I keep my job, don’t get sick and I’m not hit with any large unexpected bills”? Chances are you probably have. But things can and often do go wrong.
Causes of mortgage stress
A study2 was completed for the Royal Melbourne Institute of Technology (RMIT), which looked at the specific triggers that have resulted in Australian households being unable to meet their mortgage repayments. Survey respondents were asked the initial causes and, if they changed, what the final causes were. They were also able to identify more than one cause. The graph below shows the results.
How to reduce stress
Like most things in life, it’s difficult to make borrowing a stress-free exercise, but there are a few things you can do to reduce the angst.
1. Don’t borrow the maximum amount
Most financial institutions determine the maximum loan they will provide based on a multiple of your income and other factors. But if you borrow the maximum amount, you may find you are stretched from day one unless you are very disciplined with your budgeting.
2. Build up a buffer
It’s a good idea to hold (or build up) a cash reserve in a mortgage offset account to provide a buffer that can be drawn upon to meet your loan repayments if you become ill or are off work for other reasons.
3. Take out mortgage protection insurance
Many lenders offer insurance when you take out a home loan that covers the mortgage (often up to a specified amount and for a particular period of time) if you die, become disabled or your employment ends involuntarily.
4. Take out personal insurances
While mortgage protection insurance can provide peace of mind for a limited time frame, other types of insurances should be considered. These include:
5. Fix the interest rate
Fixing the interest rate on your home loan can provide protection against rising interest rates. The downside is there are often restrictions on making additional payments into a fixed rate loan, which would limit your capacity to build up a buffer. Many people find a combination of fixed and variable rate loans works best, as additional repayments can be made into the variable rate portion of the debt.
6. Don’t add fuel to the fire
Over 40% of the people who completed the RMIT survey responded to the initial difficulty in meeting mortgage repayments by using credit cards more often than they normally would. Using debt to service debt is very likely to compound the problem.
7. Seek advice
At the first sign of a problem, it’s essential to seek financial advice, as there may be a range of potentially viable options to explore. Better still, you may want to seek financial advice before you decide how much to borrow.
AGS can help you assess your budget and determine your affordability level. Our Financial Planners and Mortgage Brokers can help you to focus on other goals you may want to achieve in the short, medium and long term and the cash flow that may be required to meet them. They can also assess your insurance needs and advise you on a range of other financial matters.
To find out more, contact AGS today.
Source: Understanding human behaviour in financial decision making: Some insights from behavioural economics. Paper to accompany presentation to No Interest Loans Scheme Conference “Dignity in a Downturn” June 2009. Ian McAuley, Centre for Policy Development and University of Canberra.
Source: Mortgate default in Australia: nature, casuses and social economic Impacts. Authored by Mike Berry, Tom Dalton and Anitra Nelson for the Australian Housing and Urban Research Institute, RMIT Research Centre, March 2010 .
AGS Financial Group Pty Ltd, ABN 70 093 990 946, trading as AGS Financial Group, are authorised representatives of AMP Financial Planning Pty Limited ABN 89 051 208 327 (Australian Financial Services Licence No. 232706). Any advice on this page is general in nature and does not take into account your personal objectives, financial situation or needs. Accordingly, you should consider the product disclosure statement for any product and your own objectives, financial situation and needs before acting on this information and before acquiring a financial product. You can obtain a copy by contacting us on 02 9966 8188.
Financial planning, corporate benefits and mortgage services are provided by AGS Financial Group Pty Ltd ABN 70 093 990 946, an Authorised Representative of AMP Financial Planning Pty Limited ABN 89 051 208 327 (AMPFP), AFS Licence No 232706. Accounting, taxation, and business advisory services are provided by AGS Accounting Pty Ltd ABN 12 166 728 696. Liability limited by a scheme approved under Professional Standards Legislation.