“Don’t sail out farther than you can row back.”
I read this Danish saying for the first time this week in an article about mortgage stress and I must say I was a little conflicted.
On the one hand, it seems sound and sensible advice for anyone thinking of borrowing to buy a home, particularly now that interest rates are low and house prices are generally rising. Plenty of opportunity to over-commit.
On the other hand, my early career mentor lived by the philosophy of “go hard or go home”, bite off as much as you can chew as growth in incomes and asset values will ensure that in future, you’ll wonder what you were ever worried about! I think though, that this bullishness was supported by the fact that he had plenty of “Plan B’s”.
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.
Underestimating the things that can potentially go wrong means you are less likely to be prepared. We can, though learn from the experience of others what has caused them mortgage stress and rather than be blasé (it won’t happen to me!) or worse, lay awake at night worrying and not taking action, put in place Plan B’s.
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 Mortgage 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.
Get control of your budget
Face it, if you don’t know where your money goes now, how can you plan for a mortgage and the contingencies that need to be in place when you have a house and mortgage.
Your budget should cater for the basic costs of living (eg food, clothing, electricity), costs associated with home ownership (eg rates/strata, insurance, water, repairs and maintenance), lifestyle expenses (eg entertainment, travel, phone/internet/pay tv) and still allow for accumulating/maintaining a savings buffer and investment strategy. This is as much about awareness as painting a picture of what life could be like after the purchase, a valuable exercise that you can get assistance with.
Accumulate a larger deposit and don’t borrow the maximum amount
It can feel like you are on the rent treadmill forever, helping someone else pay of their mortgage! Well don’t forget that just as rent is dead money, so is home loan interest. Holding off and accumulating a larger deposit can reduce the commitment you need to service your mortgage and the total interest you pay. Having a larger deposit can also reduce the upfront costs of obtaining your loan and improved equity can act as a buffer in the event the property market turns south.
When applying for a loan, 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.
Build up a buffer
It’s a good idea to hold (or build up) a cash reserve in an investment or 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.
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:
- Income Protection Insurance which can replace up to 75% of your income if you are unable to work due to illness or injury. This can ensure you are able to continue meeting the majority of your living expenses, not just your loan repayments.
- Critical Illness Insurance which can help you service or pay off your loan and meet a range of expenses in the event you suffer a specified illness, such as cancer or a heart attack.
- Total and Permanent Disability Insurance which can help you service or pay off your loan and provide an ongoing income if you become totally and permanently disabled.
- Life Insurance which can be used to service or pay off your loan and provide your family with an ongoing income if you pass away.
Check 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 your employment ends involuntarily. This cover can also include death or disability options so make sure you don’t duplicate with personal insurances discussed above.
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.
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.
A careful budget, living within your means, delayed gratification….sounds boring doesn’t it! It will bring the odds of avoiding mortgage stress firmly in your favour though.
A great idea is to get all your ducks lined up well before you take the leap and a good financial planner can help you with the habits that should serve you well. An adviser can help you assess your budget and determine your affordability level. They 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.
Importantly, a planner can help both members of a couple get on the same page about their relationship…with money. Mediation and moderation can support couples with differing views establish a mutually agreeable basis.
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.
To find out more, contact Lake Macquarie Financial Planning for an obligation free initial consultation.
- 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: Mortgage default in Australia: nature, causes and social and economic Impacts. Authored by Mike Berry, Tony Dalton and Anitra Nelson for the Australian Housing and Urban Research Institute, RMIT Research Centre, March 2010.
Important information and disclaimer
Any advice in this publication is of a general nature only and has not been tailored to your personal circumstances. Accordingly, reliance should not be placed on the information contained in this document as the basis for making any financial investment, insurance or other decision. Please seek personal advice prior to acting on this information.