“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 paper for the Centre of Policy Development and University of Canberra, Australians have a tendency to be over-confident in their 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.
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:
- 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.
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.
A financial advisor 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.
More like this
If you like this article, you might be interested to know that we share useful thoughts and information like this in our monthly financial insights email. You can subscribe to that email here. All subscribers receive a copy of our e-book: The 5 Key Pillars of Financial Independence.
General Advice Disclaimer
This article contains general advice only, which has been prepared without taking into account the objectives, financial situation or needs of any person. You should, therefore, consider the appropriateness of the information in light of your own objectives, financial situation or needs and read all relevant Product Disclosure Statements before acting on the information. Whilst every care has been taken to ensure the accuracy of the material, Paradigm Strategic Planning or Sentry Advice Pty Ltd will not bear responsibility or liability for any action taken by any person, persons or organisation on the purported basis of information contained herein. Without limiting the generality of the foregoing, no person, persons or organisation should invest monies or take action on reliance of the material contained herein but instead should satisfy themselves independently of the appropriateness of such action.
Paradigm Strategic Planning Pty Ltd is an Authorised Representative of Sentry Advice Pty Ltd AFSL 227748