The Answers to Mortgage Stress

Warning: The long term answer to mortgage stress is, very rarely, more debt.

Issues:

When your minimum loan repayments take about 30% or more of your take home income, you are in what is commonly known as mortgage stress. You may not feel it now. You may actually feel pretty good with the current calming effect of a low home loan interest rate, or rising property values. Your income and spending may be stable, and life feels in balance. But chances are, one slight change in your financial situation, could lead to a whole lot of trouble.

Now, I’m not a doomsayer, or negative by nature. Quite the opposite. I’m an optimist with the advantage of a front row seat to the finances of ordinary people. I’ve seen what works, and what doesn’t work. The good news is, that it can be pretty simple. The bad news…..many people don’t want simplicity. Such is life!

My oldest, wisest and wealthiest clients, have been my best teachers. They have, long before they met me, lived well within their means, paid off their debts, saved and invested, and when it comes to borrowing, have been very cautious. This doesn’t mean that they haven’t used loans to buy their homes, or even to invest, and it definitely doesn’t mean they’ve lived on the cheap and sacrificed all that much. Families that manage their debts and their cashflow well, almost always end up wealthier (and with less stress) than those that don’t. They have the most things that they want in life, and almost never have a cash flow crisis. They are just happy to wait a little longer at certain times to avoid the trap of debt.

Sadly, all to often I see the negative wealth effects that mortgage stress can bring. Like a moth to the flame, some people can’t resist the offer of easy credit today, to buy something that just can’t wait. A new car to replace an old car that works fine. A four bedroom home for a family of two. A $50,000 wedding! A holiday on a credit card! Debt offers a quick an easy fix upfront, for a long term commitment of your “hard earned” for the years that follow.

For a family that isn’t prepared for change, life’s great and only certainty, problems frequently occur when:

  • Incomes fall – due to reduction or loss of employment
  • General living expenses rise – food, health or school costs go up (and up and up) higher taxes, changing family needs
  • Interest rates rise – adding to loan repayments
  • Personal debts (outside of the home) are not under control – eg; credit card has a significant balance (more than a fortnight’s income) that cannot be cleared each month

If one or more of the above issues present a significant risk to your situation, the plan should be to stop and think. Think about the scenarios above and apply a “stress test” to see how you might cope with the unexpected. Try to suspend your disbelief. Just humour me for a minute. The common misconception in life is that “it won’t happen to us” but ask yourself:

“can I handle a loss of an income through reduced working hours?”

Or

“would I need to borrow more money from my bank/credit card/parents/loan shark if things got tight”

Whether your test is a complex calculation involving spreadsheets and economic analysis, or just a simple question asked quietly and honestly to your partner over dinner, the answers may be illuminating.  My view: Unless you are luckier than the average person, you cannot safely borrow your way out of debt.  Care should be taken to reign in the spending. Start the dreaded BUDGET, in order to reduce your current loans where:

• The minimum required repayments are less than 30% of your net income
• A rate rise of up to 3% from current levels will not put you back into mortgage stress

The reasoning behind this is simple

  • Mortgage rates are closer to the bottom of the cycle than they are to the top
  • It may be several years (3-7 years) before the rates are substantially higher but a 30 year mortgage commitment demands longer term thinking than getting by week to week
  • Employment income in a post-boom environment is less likely to rise during a period of rising interest rates
  • The equity you have in your home is essentially useless unless you sell it and use it for other purposes

A loan is a claim on your future income. A bank will own a big chunk of your productive output for many years. How many years do you want to be working for the bank?