20 Apr Why we are borrowing more
With low interest rates and burgeoning property prices, the result has been that we are borrowing more. Bessie Hassan sees this as a big problem.
Kevin: Consumer advocate Bessie Hassan from Finder.com.au joins me to talk about an alarming piece of research that’s come out that talks about how Australians are borrowing more in their housing debt. No doubt this is on the back of cheaper home loans.
Bessie, this is a bit of a concern, isn’t it?
Bessie: It is a bit of a concern. We’re seeing people overextending themselves, actually. With interest rates at an all-time low, people are perhaps getting a little carried away and taking out more than they can afford in the long run. The key here is to always factor in a buffer. We always recommend a buffer of 2% to 3% to allow for any future rate rises if and when they do happen.
Kevin: Yes. We’ll talk more about that buffer in a moment, because I think that’s the key point we want to get through in this message. But I see here that housing debt per Australian adult has actually doubled over the last 11 years, and when you think about property prices, if you look at what’s happened to property, it’s more than doubled over that same period, though, hasn’t it?
Bessie: That’s correct. Increasing property prices have pushed up loan sizes, but this is growing much faster than inflation. Inflation would have only increased by about 34% in the same 11-year period. Instead we’ve seen property skyrocket in value by a whopping 136%. Now that’s particularly property debt that I’m referring to.
Kevin: Yes. We want to get some tips here on managing our debt a lot better, but you mentioned there about the buffer, and I think this is a key thing. Explain to me how that buffer works and how we can factor that into our borrowing.
Bessie: Absolutely. With interest rates at historic lows at the moment, borrowers really do need to be cautious. Take into account that while interest rates are super low at this stage, they are probably going to rise, and all signs are pointing to a rate rise in the future. This means that during the life of your mortgage, which is usually a 30-year mortgage, you will probably have to encounter at least a few rate rises.
With that in mind, you should have a buffer of 2% to 3%. So if rates are currently hovering around the 5% mark, when you are doing your finances, when you are taking out that mortgage, ensure that you would be able to pay it back if rates were to be around the 7% or 8% mark.
Kevin: Yes, and when times are good, too, you should be looking at things like lump-sum payments, making fortnightly or even weekly payments, to get the principal down as fast as you can.
Bessie: Exactly. Simply put, a decrease in how much you owe is probably the simplest way to cut down risk.
Bessie: You can pay off your mortgage sooner by doing things such as that – making fortnightly or weekly repayments or lump-sum repayments. Also having an offset account is a great option for those looking to repay their loan sooner. It’s like a regular transaction account but directly linked to your mortgage account, of course, which offsets the amount of interest that you’re paying against the overall loan.
Also, small change counts. So if you do come across that bonus or unexpected funds coming your way, put them on to the mortgage. It might look like a small amount, but in theory, anything that you can put towards it now will help to alleviate any financial pressures down the track when the rates do go up
Kevin: Yes. I mentioned, too, earlier making fortnightly or even weekly payments. You don’t have to be that extensive if you can’t afford it. Even rounding it up – and you were hinting there at rounding up and putting in lump sums – but even if you can only make an extra $10, $15, or even $20 a week as an additional payment, it’s all going to help.
Bessie: That’s right. Over the life of your loan, you probably could save thousands of dollars. Take fortnightly for example, if you do make fortnightly payments you end up making that one additional payment per year, which helps to decrease your balance, which then reduces the amount of the interest that can be charged to your loan account. So it really is a win-win. By doing so, as well, you can probably cut down your loan term by an average of five or six years.
Kevin: Consumer advocate from Finder.com.au, Bessie Hassan. Thanks for talking to us, Bessie.
Bessie: Thank you.