debt consolidation traps

Debt consolidation traps to avoid as you reduce your debt

29 Jun, 2016

If you’ve crunched the numbers and have found a debt consolidation strategy that will definitely save you money on interest charges, there are just a few more things to consider before you take the plunge and fall for hidden debt consolidation traps.

 

Protect your home

If you’re planning to consolidate your debt by folding it into your home loan, remember that all of your debt will then be secured by your home. This means that if you are unable to keep up repayments for whatever reason, you risk losing your home – all for the sake of a few thousand dollars on a credit card. If you keep your credit card or personal loan separate, the debts remain unsecured and won’t affect your home. This is one of the biggest debt consolidation traps that individuals fail to realise.

Combining your debts in a home loan may also mean that you’re not eligible for help in the future if you fall on hard times. Lenders’ hardship programs exist to allow borrowers to request a change to their repayment schedule in the case of redundancy, illness, or other unforeseen circumstances which make repayments difficult. One important criteria though, if you took out your loan after 1 July 2010, is that only loans of less than $500,000 are eligible for a hardship variation.

If your debt consolidation is going to push your home loan over this limit, it may be best to re-think your options, otherwise you’ll be relying on the goodwill of your lender to help you out if you do hit trouble in the future. If your lender isn’t feeling too philanthropic, they have the right to foreclose on the loan and repossess your home.

 

Get to the root of the problem

So you’ve got your debt consolidation strategy in place and you’ve even managed to lower your monthly repayments, meaning you’ve got a bit more spare cash each month. But be really honest here; are you going to put the extra money into paying off your debt sooner or are you just going to continue with the bad spending habits that got you into this pickle in the first place?

One thing that debt consolidation doesn’t do is address the underlying issue of poor financial management or irresponsible spending. Once your debt is clear, what’s to stop you celebrating with a big spending spree and maxing out those cards once more?

If it’s overspending or living beyond your means that’s got you into this position in the first place, creating a budget may be the best way to tackle the root of the problem. You can have a go at doing this yourself, or turn to a financial counsellor who can act as your mentor to help you stay on track. To find someone near you who provides this service, check financialcounsellingaustralia.org.au.

 

Debt consolidation traps to avoid:

  • Consolidating your debt into your home loan can put your home at risk if you fall behind with repayments
  • Pushing your mortgage value over $500,000 means you won’t be eligible for certain hardship help, if needed
  • Take steps to tackle the bad habits that got you into debt in the first place; a budget is a good place to start

 

debt consolidation

Debt consolidation: what are the options?

27 Jun, 2016

Are you wondering whether debt consolidation could help you get your finances under control?

If you’ve ever tried juggling, you’ll know it’s a lot harder than it looks. Unless you’ve had a great deal of practice, you’ll quickly find your arms and hands won’t do what you want them to and whatever you’re trying to juggle falls quickly to the floor.

It can feel just like this when you’re trying to juggle multiple debts, too. Even if you have debt from just a few sources, it can be difficult to keep track of everything at once and in the end one or more of them will get the better of you.

You might just miss the odd payment, or forget to check your rate to see if you’re still getting a competitive deal. Maybe it’s becoming harder and harder to work out how to spread your cash over so many payments each month. However it happens, a situation like this can quickly escalate and if you’re hit with some other unexpected cost it can be enough to bring everything crashing down.

Debt consolidation is one possible way out of a scenario where it feels like you’ve lost control of your debt. It means paying out multiple debts by combining the balances into one new, more manageable loan. This can make your debts easier to handle, with the potential to reduce your monthly repayments and save yourself money on interest and other charges.

However, do be aware that debt consolidation is not an overnight ‘quick fix’, and any lending organisations claiming that it is are probably not working with your best interests in mind. Organising and clearing your debt will take time and effort, but it can be done. Take a cautious approach to debt consolidation though, and make sure you’re doing it in a way that will improve your overall situation.

 

Considering your debt consolidation options

You have three main options when it comes to consolidating your debts. The first, transferring your debt to a credit card using a balance transfer deal, is covered in more detail in a separate article. Another option is to take out a personal loan to cover all of your outstanding debt. Lastly, you could consider folding your debts into your mortgage if you have some equity built up in your home.

Whichever option you choose, the whole point of the process is to save you money, and this means you need to crunch some numbers upfront to find out how much you’ll really benefit.

To begin with, gather all of the paperwork relating to your various debts. Loan statements should show you your regular payment amount, the applicable interest rate, and – hopefully – any other fees or charges. You’ll be able to add up your regular payments quite easily but calculating the long-term interest cost on each debt can be harder. The online calculators on the government’s MoneySmart website (moneysmart.gov.au) might help with this, or you can choose a reputable broker to help you calculate the potential savings you’ll achieve from debt consolidation.

Here are a couple of examples to show how debt consolidation can work:

 

Option 1: Take out a personal loan to cover other debt

Beth has three credit cards, but they’re all maxed out and she knows she needs to do something to fix her finances. Her first card has a debt of $3,000 charging 17% interest; the second has a balance of $2,500 at 19%; and the third has $3,000 of debt at 16%. That’s a total of $8,500 of debt against Beth’s name.

She only pays back the minimum repayment amount every month on each of the cards – just 2% of the balance – totalling $170. If she carries on like this, it will take more than 25 years for her to clear her debt and she will have forked out almost $16,200 in interest charges, so that’s clearly not a sensible option. And these numbers assume that Beth makes no additional purchases on the cards which, let’s face it, is unrealistic.

By taking out a personal loan to pay off the credit card debts, Beth can reduce her overall interest bill, have a fixed payment schedule, and become debt-free significantly sooner. If she gets an $8,500 loan charging 13% interest, by paying back $194 per month (just a little more than she was paying on the cards) she can clear her debt in five years. The total interest cost in this scenario would be around $3,100 – much better than the bill she was facing if she kept the debt on her credit cards.

This is a pretty good debt clearance strategy for anyone stuck with high-interest debt from a number of sources. Unlike the option of a credit card balance transfer, having a fixed repayment schedule on your loan means you don’t have to rely on self-discipline to make extra repayments.

In addition, you can’t add to the balance of a loan, and if you cancel the cards that got you into this situation in the first place (strongly advisable), you have no opportunity to rack up further debt.

Do note that for this to work for Beth, and for her to make big savings in the long run, she had to increase her monthly payment slightly. Many people view debt consolidation as a way to reduce monthly repayments – which can be an option – but you need to look at the total interest cost over the lifetime of the product to see whether it’s really going to save you money.

Whatever your debt consolidation strategy the same rule applies: paying more back now will save you money on interest in the end.

 

Option 2: Add your debts to your home loan

If you already have a mortgage and have built up some equity in your home, you have the option of folding your debts into your home loan. One benefit of this is that the interest rate on a home loan is generally far lower than those available on credit cards and personal loans. However, because the term is so long, the extra interest charged on the added debt can still add up to an awful lot as the years go by. Again, it’s crucial that you do the maths first so you can be clear how much you are really saving by taking this option – you may be surprised to find that your overall loan cost actually increases despite the lower rate.

Let’s take the example of Matt, who has a $24,000 car loan (at 9%) and a $20,000 personal loan (at 14%), both with a five–year term. He also has a $200,000 mortgage with a term of 25 years (costing 6.5%). In this current state, Matt makes repayments of around $2,300 per month, and he will end up paying about

$219,000 in interest to clear all of the loans.

If Matt consolidates his debt by combining his car loan and personal loan with his mortgage (thereby increasing it to $244,000), his new monthly payment will drop to a much more manageable $1,650 – a saving of $650 per month. This seems like a good choice if you just look at the monthly repayment amounts, but remember that the car loan and personal loan are now accruing interest not for five years, but for 25. This means that the overall interest bill will be around $250,300 – that’s $31,300 more than if Matt had continued with his original loan repayment structure.

Fortunately, there is still a way to make this option work for you, it just requires you to pay back a bit extra on your newly expanded home loan each month. In Matt’s example above, he could counter the additional interest charges by paying back just $80 extra each month on his loan – still leaving him with a lot more free cash each month. The more he increases the repayments, the more he will save in the long run.

It’s vital to keep this in mind when you consolidate your debts. If you don’t make an effort to pay back the extra debt as quickly as possible, you may not be doing yourself a favour at all.

 

Don’t forget the other costs

It’s not just interest charges that you need to take into account when doing the sums on your debt consolidation strategy. Remember that your current lender may apply a fee for you to discharge your existing debt, and there will probably be charges if you transfer your balance or take out a new product. These must be factored in to give you a true picture of which option will work best for you.

If the numbers seem to add up for you, make sure you know about the other potential pitfalls when it comes to debt consolidation.

 

Summary: Pros and cons of different consolidation options

Credit card balance transfer

  • Pros: Zero or low interest rate during the introductory period gives you time to make some good progress with your debt
  • Cons: When the introductory period is up you’ll be hit with an inflated ‘revert’ rate which can quickly wipe out any progress you made
  • Cutting up your cards will remove the temptation to add to your debt further

 

Personal loan

  • Pros: You have a fixed repayment schedule and a clear ‘debt-free’ date to work to. The shorter term can mean interest savings in the long run. You may have the option to make extra repayments and clear your debt sooner
  • Cons: The rate will be higher than a home loan, and you may be charged ongoing fees which add to the cost

 

Home loan

  • Pros: You’ll have access to the lowest rates and should have the option to make extra repayments to pay the loan off sooner
  • Cons: Only available if you already have some equity in your home. The longer term means interest can pile up if you don’t make extra repayments

 

how to choose the right property investment loan

How to choose the right property investment loan

24 Jun, 2016

If you’ve weighed up the pros and cons of gearing and decided it’s the way forward for you, it’s time to have a look at the kinds of loan products available to you as an investor. Firstly, if you have a property investment in mind, you’ll need to secure a property investment loan.

 

Mortgages for rental properties

Property investment loans are, on the surface, not much different to regular home loans. You should shop around for the best deal exactly as you would if you were purchasing a property to live in. The main differences lie in the kinds of benefits that you should be looking for as an investor.

For example, a mortgage for your own home should give you the option to make extra repayments so that you can clear the debt sooner and minimise interest costs. As an investor, however, this isn’t so important because you can claim the interest cost as a tax deduction anyway. In fact, making extra repayments to reduce the interest cost will increase the property’s profit and may result in you being liable to pay tax on the rental income, so you could end up worse off.

 

Fixed rate or variable rate?

Another similarity is that you’ll be able to choose between a fixed rate or variable rate loan. Fixed-rate property investment loans are often more appealing to landlords, for a couple of reasons.

Firstly, knowing exactly what your repayments will be for a fixed term makes it easier to manage your investment profitably. Since variable rates can change without notice, they add an extra element of risk for landlords. If you just signed a six month contract with a tenant and interest rates rise the next week, pushing up your repayment, you won’t be able to pass on the extra cost to the tenant until the six months are up. On the other hand, a fixed-rate loan gives landlords the security of knowing their repayments won’t change for the length of the term.

Another benefit of a fixed-rate loan is that if you know the annual interest charge upfront, you have the option to prepay up to a year’s worth of interest on the loan before the end of each financial year. You can then claim this prepayment on tax to lower taxable income if other income sources are higher than normal, or other costs are lower. This is just another (perfectly legal) way to balance your income and expenses to minimise tax payments – it just relies on you having the funds available to prepay the interest.

 

Interest-only or principal plus interest?

For the first few years that you’re paying a mortgage, the majority of the money is going towards interest charges rather than actually reducing the amount owed. Another option is to choose interest-only payments, where your repayments only cover the cost of interest and you don’t pay back any of the principal (the original amount borrowed). So you could borrow $400,000 on an interest-only loan, make repayments for 15 years, and still owe $400,000 at the end. The principal is usually paid back in full when the investment is sold, hopefully for a profit. Why would you want to do this? Well, on an interest-only loan the monthly repayments are lower, making your property investment loan more affordable.

This may seem like an attractive option but if you’re buying a home to live in you should really avoid interest-only mortgages as you want to be able to own your home outright one day – and that won’t happen if you’re only paying interest and not making any contribution towards the principal.

For property investment, however, an interest-only mortgage can make more sense.

The key to the majority of property investments is capital growth. You buy when the markets are low, hold onto the property until prices rise, and then sell it on for a profit. You’re relying on appreciation to make up the bulk of your return on investment as rental income usually goes straight towards your mortgage repayment. Renting out a property is generally a long-term investment, as you need to ensure you cover the substantial upfront costs of the purchase before you can start counting your profits.

Perhaps the exception is in the case of experienced tradespeople who take advantage of a run-down property at a bargain price, renovate it themselves, and sell it on for a profit straight away.

In both of these cases, interest-only may be the right choice for your property investment loan.

Interest-only loans are available with both fixed and variable rates, but your lender will limit the term for which you can continue interest-only payments. When this expires, usually after five years, you will have to start repaying interest plus principal or renegotiate a new interest-only term.

 

Line-of-credit loans

There was a time when line-of-credit loans were very popular among investors, but they have lost their popularity post-GFC and now only account for around 3% of all mortgages. This is not a bad thing really, when you consider the risks involved if you want to pursue property investment.

You can think of a line-of-credit loan as a revolving door of debt which you can take away from and add to, up to a certain limit, as you please. It doesn’t come with any fixed repayments; you just pay into it as it suits you and then make withdrawals again if needed. You can see how this would be handy for a property tycoon who has a number of properties on the go and needs easy access to funds, but unless you know what you’re doing and can manage your money responsibly, the interest charges can make it an expensive way to borrow.

If you’re still new to this game, best stick to a traditional mortgage.

 

Things to remember when choosing a property investment loan:

  • Shop around to find a good deal for your property investment loan that suits your needs, just as you would with any other financial product
  • Making extra repayments on an investment loan may not save you money overall because it will affect your tax deductions
  • A fixed-rate loan can give landlords a more secure option than variable-rate. It also offers more opportunities for tax savings
  • Interest-only loans, while inadvisable for homeowners, may be suitable for investors
  • Line-of-credit loans are best avoided unless you’re a seasoned property investor

 

investment gearing

Investment gearing: how debt can increase your wealth

22 Jun, 2016

We’re all familiar with the concept of borrowing money for a home. We take on a huge amount of debt but recognise that over the course of the loan the property will grow in value, in most cases becoming the most expensive asset we own. But there are other ways that debt can be used to fund investments and ultimately make us money – a practice known as ‘gearing’.

Options include investing in a rental property or purchasing shares or units in a managed investment fund. These all come under the umbrella term ‘effective debt’ as the debt is being used as a tool to build wealth.

 

What is ‘gearing’?

‘Gearing’ is the technical term for borrowing to fund an investment. When used well, it can see your money multiply and deliver healthy tax breaks. On the other hand, poor decisions can lead to financial ruin; even if the initial investment falls to pieces, your lender still expects to be repaid. This means that any gearing strategy should be viewed with a fair amount of caution.

The GFC had a disastrous effect on the Australian sharemarket, creating the worst downturn it had seen in two decades. Many shareholders who had borrowed heavily to invest were left with no option but to sell their shares at a huge loss in order to pay back their loans, wiping out any capital they had invested.

The collapse of high-profile firms such as Storm Financial has left other investors with no assets and big debts to repay, worsened by the fact that these companies actively encouraged people – in many cases retirees – to borrow money to invest.

Although these are extreme examples, they illustrate the potential pitfalls of gearing that borrowers need to be aware of in order to make a fully informed decision.

 

The benefits of gearing

There are several aspects of gearing which make it an appealing option for potential investors.

Quick portfolio building

Even if you don’t have much to invest, gearing lets you purchase high-value investments such as a rental property or extra shares that you couldn’t otherwise afford. A special type of loan called a ‘margin loan‘ may enable you to build up a share portfolio worth $100,000 by using just $25,000 of your own money, for example.

Amplified returns

If you use debt to fund your investment, providing you receive the expected returns, this has the effect of magnifying the return on your capital investment. Let’s look at a couple of examples to illustrate this.

Say Amelia buys an investment property for $400,000 using a 10% deposit of $40,000. Her tenant pays annual rent of $20,000. That means a gross (before expenses) rent return of 5% on the property purchase price, but a 50% return on Amelia’s investment of $40,000.

Shares work in much the same way. Imagine Ryan buys 10,000 $20 shares in a company – a total investment of $200,000. He uses $100,000 of his own money and an additional $100,000 which he has borrowed. After one year, the shares rise in value to $22, adding $20,000 to the value of Ryan’s portfolio. This works out as a 20% return on his capital in just one year.

It’s clear to see the appeal of gearing as a way to make a quick profit on your investment. But it’s not all rosy; just as gearing can amplify your gains, it can also amplify your losses – more on this later.

Tax savings

If you hold assets that generate taxable income – including rental income, share dividends or distributions from a managed fund – you many claim the costs incurred from owning that asset as a tax deduction. For example, a property investor may claim expenses such as repairs, maintenance, property management fees and insurance. Possibly the biggest area where those with a geared investment stand to save is by claiming the expense of interest charges incurred on the loan used to purchase the asset.

Negative gearing

Negative gearing applies when the costs of owning an asset purchased using debt outweigh the returns it generates. (If, however, the asset is generating a taxable profit because the returns are greater than the associated costs, the investment is positively geared.) Negative gearing has received a lot of media attention recently so you may well be familiar with the term, but let’s look at what it means in practice.

Take the case of a hypothetical investor, Nathan, who earns a salary of $120,000. He pays tax (plus Medicare levy) of $34,147 on this income.

Nathan invests in a rental property which earns annual rent of $30,000, but he has to fork out $10,000 in annual expenses as well as paying $42,000 per year in interest on his loan. This means total running expenses of $52000 – an annual loss of $22,000 when you take into account the rental income.  Being a savvy investor, Nathan offsets this $22,000 loss against his salary of $120,000, meaning his taxable income drops to $98,000 and he only has to pay $25,677 tax. His negatively geared investment has cut his tax bill from $34,147 to $25,677, giving him a yearly saving of $8,470.

High-income earners stand to gain the most from negative gearing since they have paid the most in tax in the first place. If Nathan earned a lower salary of $50,000, his annual tax savings from the same property would only be $6,460.

 

The downsides of gearing

As previously mentioned, using gearing to invest doesn’t always bring about quick and easy returns. It’s important to be aware of the potential risks before embarking on this route.

Amplified losses

We looked earlier at how investment returns can be magnified through gearing, but the same applies to losses if something goes wrong.

Let’s go back to our investor Ryan, who purchased $200,000 of shares and funded half of this with a loan. If, instead of rising in value, the share value drops from $20 to $17, Ryan’s portfolio will fall by $30,000 in value to $170,000. That’s a loss of 15% on the whole investment but Ryan personally is down 30% on his initial investment of $100,000. If Ryan had avoided gearing and just bought half as many shares using his own capital, his losses at this point would be $15,000 instead of $30,000.

As shares can subject to greater price fluctuations than other investments, one way to minimise potential losses is to maintain a low level of gearing.

Unreliable income to pay back debt

If you’re relying on your investment returns to meet your loan repayments, you could be setting yourself up for trouble. Long-term, the return on an investment like property or shares will be sufficient to cover the charges incurred through loan interest, but short-term there may be unexpected breaks in income.

Shares provide no guarantee of returns; companies may at any time reduce dividend payouts or stop them altogether. Likewise, a rental property is bound to be vacant at some point and may require maintenance which wipes out a few months’ worth of rental income.

Whatever happens to your investment, your loan still needs to be repaid so it’s important to have another source of income that you can fall back on to meet the repayments, at least in the short term.

If your budget is already tight, gearing your investment may not be a wise choice. If you fail to make the repayments you risk losing everything you’ve invested plus anything else you’ve put up as security – in many cases this could be your family home.

Getting carried away by tax savings

For many, the main appeal of negative gearing is tax savings. We can easily get carried away when we feel like we’re getting one up on the tax man. The thing is, a bad investment will still lose you money, no matter how much of a tax deduction it offers. Remember you still have to factor in the cost of the interest you’re paying on the loan, plus any fees, plus the overall appreciation or depreciation of the asset. A $7,000 tax break is nothing to brag about if you spend $10,000 in achieving it.

Keep things in perspective and never enter into an investment purely for the tax savings it offers. Tax benefits should be seen as an added bonus to a quality investment with the potential for strong returns.

 

Let’s summarise:

  • ‘Gearing’ means borrowing money to fund an investment, and it can be positive or negative depending on whether you make or lose money each year
  • Gearing, when applied carefully, can amplify your returns, offer tax savings, and help you build a portfolio quickly
  • Equally, gearing can amplify your losses and leave you in trouble if you can’t meet your loan repayments
  • Never enter into an investment purely because of the tax savings on offer; make sure it makes sound financial sense regardless of tax breaks

 

margin loan for shares

Investing in shares with a margin loan

20 Jun, 2016

If you decide you want to make a geared investment in the form of shares or units, you’ll need a margin loan. This is a special kind of debt which allows the borrower to purchase shares or units in a managed fund.

You will need some level of equity though; a margin loan is more like a mortgage than a personal loan in that the lender will only let you borrow up to a certain percentage of the asset value.

How do margin loans work?

A margin loan allows you to buy any shares within the lender’s ‘acceptable securities’ list. This list will vary from one lender to another but most banks and other financial institutions offer several hundred securities to choose from, including shares listed on the Australian Stock Exchange plus quality managed funds.

The exact amount you’ll be allowed to borrow is determined by the lender’s loan-to-valuation ration (LVR) – the amount you can borrow shown as a percentage of the total asset value. The exact LVR will depend on the lender and your choice of security. For example, you may be offered an LVR of 75% if you’re investing in a blue chip company, meaning your deposit would have to be 25% of the value of the underlying security and the lender would supply the remaining 75%. In this case, a $30,000 deposit would buy you $120,000 in shares.

On the other hand, if you’re investing in a less dependable company with a higher element of risk, the LVR may be as low as 40%. In this case, your $30,000 would only get you $50,000 worth of shares as the lender is only prepared to put up 40% of the investment.

 

How do margin loans increase my return?

Margin loans allow you to invest a relatively small amount of capital but still reap 100% of the returns from the asset – whether in the form of dividends (shares) or distributions (managed funds) – with the added benefit of capital growth over time. As a company shareholder you will have normal voting rights although the security itself is held in trust by the margin lender (this can become important if your investment loses value – more on that below).

In the table below you can see how a margin loan can add significant value to an investment of $50,000.

Assume this investor buys shares which grow by 10% in the first year. The non-geared investor will then have a portfolio worth $55,000 and if we add in a dividend payment of 5% (which we’ll say is reinvested), that becomes $57,750, representing a 15.5% increase on the $50,000 capital invested.

If that same investor used a margin loan with a 50% LVR, the capital growth and dividends are doubled. We must account for the extra cost of loan interest (which could still be tax deductible) so the one-year return for this investor works out at 23.5%.

It’s an even better return for the 75% LVR investor, whose $50,000 investment makes a 39.5% gain in just one year.

Gearing with a margin loan is clearly a good way to make your money work harder for you.

 

Potential benefits of gearing a shares purchase

 

Invest with no gearing Invest using 50% gearing Invest using 75% gearing
Investor’s own capital $50 000 $50 000 $50 000
Loan value $0 $50 000 $150 000
Value of share portfolio $50 000 $100 000 $200 000
Capital growth (10%) $5000 $10 000 $20 000
Portfolio value $55 000 $110 000 $220 000
Add: Dividends (5%) $2750 $5500 $11 000
Less: Interest cost (7.5%) $0 $3750 $11 250
Equity after 1 year (portfolio value plus dividends less loan and interest charge) $57 750 $61 750 $69 750
Return on invested capital 15.5% 23.5% 39.5%

 

The risk of investing with a margin loan

Of course, this kind of investment doesn’t provide a risk-free way to earn annual returns of 40%. There’s a catch – and it’s a big one.  The LVR on the underlying security is fixed, meaning it must not exceed this level for the duration of the investment. So if you buy shares with a 50% LVR loan, the shares must hold their value well enough that the loan value never exceeds 50% of the value of the shares.

Due to the volatility of the stock market, there is every chance that price fluctuations may push you over your LVR, and that’s when you can expect to receive the dreaded ‘margin call’.

Simply put, a margin call is a phone call from your lender asking you to take action to get the LVR back to its approved level. You may do this by injecting a lump sum of cash into the loan, by providing additional security, or by selling some of the shares, but you will typically only be given 24 hours to do this. After that tight timeframe has passed, the lender has the right to sell the underlying security – remember a margin lender keeps hold of the security so is in a position to sell without your approval.

Having to arrange any remedial action within 24 hours can prove extremely stressful and may lead to assets being sold for a loss, only to recover their value within a matter of days or weeks (frustratingly for the investor, who has already lost out).

 

Managing margin loans

The fallout from the GFC saw the amount borrowed through margin loans fall from $37 billion at the end of 2007 to $18 billion by September 2009 – that’s a lot of people deciding their money is better off elsewhere or simply running out of cash to invest full stop.

Again, it’s important not to push yourself to your borrowing limits when an unpredictable asset like shares is involved. If you’re just starting out, aim not to borrow more than 50% of your investment portfolio and have some spare cash to dip into in case you find yourself in a ‘margin call’ situation. It’s easy enough to gradually increase your investment over time as you become more experienced and confident in the market.

The golden rule, as with any investment you are borrowing for, is to buy the best-quality asset you can afford and have a full understanding of how the investment and the loan work. Whether the investment succeeds or fails, you’ll still be expected to cover the loan, and if you’re stuck paying it back from your regular paycheque you could soon find yourself in difficulty.

If you’re at all unsure about gearing, you can always hold off a while until you’ve built up a bigger deposit which will increase your equity percentage and reduce your exposure to the risks involved.

 

Margin loans in summary:

  • Margin loans are designed for borrowers who wish to invest in shares or managed funds
  • Your loan-to-value ratio (LVR) dictates how much you can borrow depending on your lender and investment choice
  • Margin loans provide a great opportunity to get more from your money but also present added risks in a volatile market
  • If starting out, keeping your loan value below 50% of your asset value will offer some protection

 

pay your mortgage

Struggling to pay your mortgage? Here’s what you can do

17 Jun, 2016

When you buy a home, the last thing you wish for is to one day be struggling to pay your mortgage each month. But it can happen to anyone, whether because of redundancy, a death in the family, an unexpected expense that throws your finances off balance, or just a gradual build-up of poor decisions.

No matter how you have found yourself in this trouble, the most important thing now is that you don’t put off taking action. The longer you leave it, the worse it will get and you could put your home at risk if you don’t start to pay your mortgage again soon.

What to do next depends on whether you’ve managed to keep up with your repayments so far or you’ve already fallen behind.

 

If you haven’t missed a repayment yet

If you’ve scraped together enough for the last few months but don’t feel like you can keep it up, contact your lender immediately and ask to speak with the ‘internal customer relations department’ or ‘internal disputes resolutions department’. Explain that you’re struggling with your loan repayments but show that you’ve thought about how to get back on track, whether it’s by working overtime, freeing up money from an investment, or reducing your household expenses (perhaps by selling a second car).

If you have experienced a death in the family, been made redundant, or have been affected by some other factor beyond your control then you may be eligible for a ‘financial hardship’ application under the Code of Banking Practice. The major banks have financial hardship divisions set up specifically to deal with borrowers in this kind of situation. More information about financial hardship and contact details for most banks can be found at doingittough.info.

Following this conversation, your lender may offer you a range of options to provide short-term support. It could be a repayment ‘holiday’ that gives you a break from repayments while you recover your finances, or a complete overhaul of your loan to extend the term and give you lower monthly repayments. Think carefully about these offers, as they may provide you with an alternative to drastic action like selling your home.

If you are not satisfied with your lender’s response, you may lodge a dispute with the Ombudsman. If your lender is a bank, contact the Financial Ombudsman Service through fos.org. au or phone 1300 78 08 08. If your loan is through a non-bank lender, contact the Credit Ombudsman via creditombudsman.com.au or phone 1800 138 422. These services are free, but won’t always decide in favour of the borrower as the Ombudsman takes a neutral approach. To get an idea of how disputes may be settled, review the ‘Cases’ section on the Financial Ombudsman website.

 

If you’re already behind with your payments

Once you miss a mortgage repayment, your lender will probably send you a default notice giving you a further 30 days to pay your mortgage for the month. It’s crucial that you act quickly from here – those 30 days will be up before you realise it. Get in touch with the relevant Ombudsman service to delay your lender taking legal action and to give you time to get your finances in order. If you’ve already passed the 30 days set by your lender, the Ombudsman may not be able to help.

If your loan is worth less than $500,000, the Ombudsman can force your lender to adjust your monthly loan repayments, but it takes time for any steps like this to be put in place. In the meantime, it’s a good idea to keep meeting your repayments as best you can rather than stopping them altogether.

 

Don’t be tempted by ‘fix it quick’ lenders

When you’re in trouble financially you may be willing to try anything to fix the problem. The thing is, there is no one solution that’s going to make it easy to pay your mortgage overnight. Clearing your debt will take time and perseverance, so be wary of anyone suggesting otherwise.

In particular, steer clear of predatory lenders whose only goal is to make money at your expense. They may offer to solve your problems instantly, but these ‘quick fix’ refinancing deals will just accelerate your debt further by transferring you to a higher-rate loan that’s subject to all kinds of unreasonable fees. Once you’ve signed that contract it will be very difficult to wriggle your way out of it, even with the help of a professional organisation.

 

One last way to take control

Unmanageable debt can be really tough to work your way out of. If, having seen a voluntary financial counsellor, it seems that there is no light at the end of the debt tunnel, you may be better off selling up and starting over.

Although you may not like the idea of letting go of the home you’ve put so much money, time and effort into, taking control of the situation now and choosing to sell on your own terms will likely secure you a much better price than waiting for a lender to foreclose on your home and force a sale.

This really is a last resort though, and with any luck you’ll find another way to stabilise your finances and eventually clear your debt for good.

 

Summary of what to do if you’re struggling to pay your mortgage:

  • If you haven’t missed a payment yet but think you might soon, contact your lender to explain the situation and see if they can help
  • The relevant Ombudsman may be able to help if you’re unhappy with your lender’s offer or if you have already missed a payment
  • In any case, take action immediately before the situation gets any worse
  • Avoid predatory lenders who promise overnight solutions – there is no such thing
  • If the situation is dire, consider putting your house on the market before your lender does it for you

 

 

should I use a mortgage broker

Should I use a mortgage broker?

15 Jun, 2016

When you’re buying a new home or refinancing an existing loan, the sheer choice of products on offer can be overwhelming. You may consider using a mortgage broker to help narrow down the options for you.

 

Using a mortgage broker can be particularly helpful if:

  • You’re really short on time
  • You have unusual circumstances (from a lender’s point of view, this includes being self-employed)
  • You don’t feel confident assessing the market and approaching lenders alone

There should be no charge for you to use a broker – they make their money via commission from the lenders they recommend. This does mean that some less-than-honest brokers may push the loan from which they earn the most rather than the one that offers you the best deal, so it pays to do some research of your own so you know you’re getting a competitive rate.

Remember that just receiving a quote from a broker doesn’t mean that you are under any obligation to take out a loan with them.

It’s worth noting that not all lenders deal with brokers. Non-bank lenders often work to very tight profit margins, which means they can offer some of the most competitive deals around but also aren’t in a position to pay broker commissions.

Conversely, others only work through brokers, so by going it alone in the market you won’t have access to lenders such as Homeside.

Ultimately, you have nothing to lose by speaking to a broker; just do your own market research and don’t rely on their recommendations alone. Websites such as canstar.com.au and infochoice.com.au provide useful rate comparison tools.

Looking for a mortgage broker? Create your free Monefly account and not only can you use our helpful budgeting and finance tools, but you can also find and connect with finance professionals all over Australia. Sign up here or log in now.

 

Broker dos and don’ts:

  • Do consider using a broker if you’re pushed for time, self-employed, or lacking confidence
  • Do research the market yourself to get an idea of competitive rates
  • Don’t rely solely on the broker’s recommendation as they can be swayed by commission rates
  • Do consider both broker and non-broker deals so you can view a full range of lenders

 

choosing a lender

What to consider when choosing a lender for your needs

13 Jun, 2016

We’re lucky in Australia to have a good selection of financial institutions when it comes to choosing a lender for a mortgage or other loan. The amount of choice on the market encourages lenders to stay competitive by offering good value to customers.

 

What to consider when choosing a lender

The majority of people choose one of the mainstream banks for their home loan (despite how much they love to complain about them), but it’s certainly worth being open-minded and looking beyond the big four in your search for a good deal.

Have a look around and you’ll find plenty of small banks, credit unions, building societies and other non-bank lenders offering home loans, and you might be surprised at how competitive they are. In recent years, increasing numbers of ‘mutual’ banks have appeared on the market. These banks, which are essentially owned by their ‘members’ or customers, have more of a community feel without any shareholders to answer to.

You might be wondering how safe it is to take out a loan with a small lender. Thankfully, we have a well-regulated financial sector so any lender that comes under the regulatory control of the Australian Prudential Regulation Authority (APRA) is pretty safe. Any banks or mutuals offering deposit accounts are classified as ‘authorised deposit-taking institutions’ (ADIs), meaning they must follow APRA’s regulations to, in a nutshell, make sure they don’t run out of money.

Non-bank lenders which do not offer deposit accounts and therefore fall outside of APRA’s jurisdiction are instead regulated by the Australian Securities and Investments Commission (ASIC) and must comply with strict responsible-lending laws. If a non-bank lender did go out of business, its outstanding home loans would most likely be taken over by another lender. All this would mean to you as a borrower is a different company’s name appearing at the top of your statements.

In any case, sticking with a reputable lender should mean there’s very little risk involved. And even if you’re in a tight spot at the end of the month, you should avoid payday lenders at all costs.

 

In short:

  • You can find good deals with the big banks but consider smaller lenders too
  • All financial institutions in Australia are covered either by APRA or ASIC and must follow strict criteria
  • Choosing a reputable lender (but not necessarily one of the big four) should ensure the safety of your loan

 

switching mortgage providers

The true cost of switching mortgage providers

10 Jun, 2016

So you’ve done your research and found a mortgage provider that’s offering a better rate than your current lender? Great! But have you factored in all the costs involved with actually switching mortgage providers?

 

Exit fees

Since 1 July 2011, lenders have not been allowed to apply exit fees to new loans. If, however, you took out your loan before that date it could still be subject to an exit fee so check your contract to see if this is the case. The fee will either be a fixed amount or a percentage of your outstanding loan balance.

 

Break costs

If you have taken out a fixed term loan, there may be a ‘break’ cost applied if you go ahead with switching mortgage providers during the fixed term. The exact cost will depend on how the market has shifted since the start of the term, so speak to your lender to find out how much this would be.

 

Lenders mortgage insurance

You can read about LMI in more detail here, but basically you’ll have to pay it to your new lender if your equity value is less than 20% when you refinance. This may be the biggest cost of all in the process, so don’t forget to factor it in.

 

And some more…

If you have enough equity to avoid LMI and your loan conditions mean you won’t have to pay an exit fee or break charge, there are still a few other fees that are unavoidable when refinancing. Here is an idea of what you can expect to be hit with:

  • A discharge fee on your current loan (around $250)
  • Registration of the new mortgage with your state/territory government (around $300)
  • Application/valuation fees on the new mortgage (allow between$400 and $600).

You’re looking at upwards of $1,000 here, so make sure you’re getting a good deal with your new lender that will make the switch worthwhile.

Fill in the numbers in the table below to work out just how much you’ll really save by moving your mortgage over. Your lender or mortgage broker should be able to work out the interest saving for you.

 

Cost of exiting current loan

 

·      Exit fee (can apply if loan was taken out before 1 July 2011)

·      Break charges (applies to fixed-rate loans only)

·      Mortgage discharge fee and any other lender-imposed costs

 

Total cost of exiting old loan

 

 

$

 

$

$

 

 

$

Cost of new loan

 

·      LMI (if home equity is below 20%)

·      Loan application fees

·      Registration of new mortgage

 

Total cost of new loan

 

 

$

$

$

 

$

Total cost of refinancing $
Interest saving on new loan over life of loan $
Saving from refinancing (total cost minus interest saving) $

 

You also need to think about how long it’s going to take before you’re actually benefitting financially from refinancing. The longer it takes, the higher the chances that you’ll be wanting to switch again to a more competitive deal before you’ve even broken even from the last one.

To work this out, divide the overall cost of switching mortgage providers by the monthly savings on your new mortgage. For example, if the switch costs $2,000 and you save $50 a month, it’ll take 40 months (3.5 years) for you to recoup the costs. You might be better off continuing with your existing loan until you’ve built up more equity or reached the end of your fixed term contract so you can avoid some of the fees.

If you do successfully make the move and end up with lower mortgage repayments, consider using the savings to make extra payments on your loan. This will give you even more benefits because you’ll save on interest costs and end up debt-free sooner.

 

Before switching mortgage providers, remember:

  • Check whether you’ll be liable for exit fees or break charges from your current provider
  • If your equity is under 20% the cost of LMI can be prohibitive
  • There are other unavoidable fees which all need to be factored in to your calculations
  • Work out how long it will take for you to actually start saving money, and decide whether it’s worth it
  • Get even bigger savings by putting the money you save straight back into extra loan repayments

 

create a budget

How to create a budget that works for you

08 Jun, 2016

Where do I begin?

Ok, so you’re mentally prepared to create a budget, you just need to know how.

To get you started, there’s a budget template at the end of this article which you can print out or fill in electronically. Alternatively, grab your smartphone and download the Monefly app for Android or iPhone – that way you’ll always have it to hand when you want to update or check it.

Creating a personal budget is not a process that should be rushed. Make sure you give yourself plenty of time to make it accurate and thorough, and get your partner or spouse involved too. You’ll need your spending diary to hand, as well as copies of your bank and credit card statements and invoices for annual expenses like car insurance. If there are any numbers you have to guess, it’s better to overestimate than to underestimate, and you can always go back and amend them at a later date.

 

Capture a current financial snapshot

First of all you need to see what your finances look like at the moment.

To create a budget, start by recording all your sources of income. This will include your wage or salary, any Centrelink payments or Family Tax Benefit receipts, and earnings from investments like interest on savings accounts.

Then, make a note of all your weekly, quarterly or annual expenses. This covers things like your house, car, family, health, insurance, groceries, and entertainment, but your budget planner should have an extensive list to jog your memory. Be completely honest and make sure everything is recorded here.

Once you’ve got your income and expenditure listed, you need to add each line up and subtract the total expenses from the total income. If the resulting number is positive, that’s great because it means you’re in a strong position to be paying back your debt and building up some savings. If the number is negative, well, you’ve got some work to do but you’ve taken an important step by just getting to this stage in the process.

Don’t forget – you can use the template at the end of this article to help you work everything out as you create a budget.

 

Assess your current situation

At this point, your personal budget is just a first draft and it shows you your current financial standings. Whether you’re in the red or the black at the end of each month, there is always the opportunity to cut back on your spending so you have more spare cash.

Try to identify a few areas where you’re habitually overspending and wasting money, whether it’s forgotten nights out, too many treats for the kids, or a wardrobe full of clothes you never wear. You really need to be honest with yourself here.

Don’t try to cut back on everything at once, unless your situation is really dire, because this will make any resolutions harder to stick to. Targeting a few carefully selected areas of spending will make the process easier and more sustainable for you. Once you’ve mastered those, there’s nothing to stop you going back and trimming a few more areas.

 

Essential or not?

As you go through this process and create a budget for yourself, you can divide your household expenses into two categories: essential and discretionary.

Things like your mortgage or rent, utilities, child care, and some groceries are essential – you need these things to live and there is no way to avoid them (although there may still be ways to trim them). You can’t just call up your water company and say you’re not paying water rates anymore because your budget says so.

On the other hand you’ve got your non-essential, discretionary spending – the things that you have more control over and are choosing to buy. This could be anything from a takeaway coffee each morning to clothes and holidays or even a second car. If it’s something you could do without, it’s an area where you should consider cutting back.

When you look at your discretionary spending, be really picky about the small things because they can quickly add up to big savings. For example, making your own coffee or lunch instead of buying it from a pricey shop, even if it’s just once a week, could save you hundreds of dollars over the course of a year.

Your spending diary will remind you of all those little things you’re buying that you don’t really need, and will show you how much they’re costing you, too.

 

Set a new personal budget

If you can identify just three or four areas where you can save $10 or $20 a week, your annual savings are already in the thousands. That money can now be channelled into paying off your debt or increasing your savings. Even the idea of it feels great, doesn’t it? Just wait until you see the numbers in action on your statements.

Every saving you commit to needs to be recorded on a new version of your budget. If you think you can manage a whole year without takeaways, put a zero in that column (you might notice the difference on the scales as well as your bank balance with that one). Decided to cancel your expensive gym membership and take up running instead? Write it down. Went a bit overboard with the kids’ birthday and Christmas presents last year? Decide on a more reasonable amount and pop it in your budget.

One of the biggest changes for you may be the switch from a ‘buy now, pay later’ to ‘save now, buy later’ attitude. If you’re serious about living debt-free, you need to adopt the mindset that if you can’t pay for it in full, you can’t have it yet.

If you find you’ve pushed yourself a bit too far and you’re really struggling to meet the new budget, just fine-tune the numbers a bit. It’s better to allow yourself an occasional treat than try to deprive yourself completely and fail.

 

Tackle your debt

All that budgeting has been building up to one important thing: getting your debt under control and eventually eliminating it completely.

But taking control of your debt means knowing all about it. Just think for a moment; do you know what the interest rate is on your mortgage or other loans? How much does your credit card provider charge in annual fees?

Now is the time to dig out your statements and make a list of all the debt you have, the amounts involved, and the interest rates and charges that you pay on it. It probably won’t be the highlight of your year but it’s an important part of the process.

With your personal budget in order, you’ve now got some money to put towards reducing this debt, and it’s a good idea to target whatever is racking up interest at the highest rate. That’s because paying off high-rate debts first will usually save you more money in the long run.

The other thing to do now that you have a clear picture of your debts is to shop around. You may find that your once-competitive card rate has crept up over the years and there are now much better deals on the market.

The easiest way to find out what deals are available is to check online comparison sites like infochoice.com.au, mozo.com.au and ratecity.com.au. However, before you rush ahead and refinance all your products to whichever company is offering the lowest headline rate, make sure you take into account things like introductory periods, switching fees, and annual charges which can push the overall cost of a product right up. There’s also a lot of time and hassle involved with switching, so take your time and research the decision properly.

 

How to create a budget: a summary

  • Find a budget planner that works for you, whether it’s a spreadsheet, a printout, an app, or the template below
  • Using your spending diary and bank/card statements, record your current income and expenses to work out your current financial position
  • Look at ways to make savings in a few select areas, focusing on discretionary spending
  • Make a list of all your outstanding debt and start by paying back the high-interest debt first
  • Enjoy the freedom of being in control of your money!

Here is an income and expenses template you can use to create a budget:

Budget Week Year
Income
Your income after tax
Your spouse/partner’s income after tax
Government support (pension, Family Tax Benefit, Child Care Rebate, child support receipts, other)
Interest on savings accounts
Investment income
Other
TOTAL INCOME $ $

 

Expenses
Home
Mortgage repayments/rent
Council rates
Water rates
Electricity
Gas
Telephone (landline, mobile)
Internet
Maintenance
Furniture
Appliances
Other
Motor vehicle
Registration
Petrol
Repairs
Loan/lease payments
Other

 

Budget Week Year
Expenses
Food
Groceries
Alcohol
Dining out/takeaway
Insurance
House and contents
Health cover
Motor vehicle
Income protection
Life insurance
Other
Family expenses
School:

Fees

Uniforms

Textbooks & stationery

Excursions

Child care
Child support payments
Pets
Sports/hobbies
Subscriptions/memberships
Public transport
Newspapers/magazines
Clothing
Personal care
Gifts
Holidays

 

Budget Week Year
Expenses
Other
Health
Doctor
Dental
Medicines
Other
Finance
Personal loan repayments
Credit card repayments
Store cards
Superannuation contributions
Other
TOTAL EXPENSES $ $
YOUR SAVINGS (total income less total expenses)