“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 in most metropolitan centres of Australia.

According to a paper¹ for the Centre of Policy Development and University of Canberra, Australians have the propensity to be over-confident in our capability to repay loans. The paper also concluded that 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 expenses”? Chances are you probably have said this yourself. Unfortunately, things can, and often do go wrong.

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 obligations. 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.

Ways you can reduce stress

Like most things in life, it’s difficult to make borrowing a stress-free exercise. There are however a few things you can do to reduce the pressure that you may feel at times:

1. Build yourself a buffer as quickly as possible

It’s always a good idea to hold (or build up) a considerable 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 unable to work because of family issues, redundancy or other circumstances.

2. It’s best not to borrow the maximum amount

Most banks and financial institutions determine the maximum amount that they will provide based on a multiple of your income, the value of the property, your other assets and liabilities, and many other factors.

Many people are surprised at the values that a bank confirms they will lend to individuals, but this does not mean you should borrow this amount. If you were to borrow the maximum amount, you may find you are stretched from day one unless you are very disciplined with your budgeting.

3. Consider whether you should 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. This insurance can be cost effective, however, it is limited for the events that it will pay out on and is best discussed with an independent financial adviser.

4. Look at personal insurances

While mortgage protection insurance can provide peace of mind for a limited time frame, other types of insurances are vital. 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. Consider whether fixing the interest rate is appropriate

Fixing the interest rate on your home loan can provide protection against rising interest rates. The downside is there can be 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 and can spiral out of control.

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. Many independent financial advisers can help you to examine your cash flow before you take out a loan, and even refer you to an independent mortgage broker who can examine all possible options in the mortgage market.

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.

To find out more, please feel free to contact our office on (03) 9999 7200 or contact us here

1. 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.
2. 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

This publication has been prepared by Dennis Maddern of Maddern Financial Advisers

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.

Information in this publication is accurate as at the date of writing, July 2016. In some cases, the information has been provided to us by third parties. While it is believed the information is accurate and reliable, the accuracy of that information is not guaranteed in any way.

Opinions constitute our judgement at the time of issue and are subject to change. Neither the Licensee nor the Adviser, nor their employees or directors gives any warranty of accuracy, not accept any responsibility for errors or omissions in this document.

Any general tax information provided in this publication is intended as a guide only and is based on our general understanding of taxation laws. It is not intended to be a substitute for specialised taxation advice or an assessment of your liabilities, obligations or claim entitlements that arise, or could arise, under taxation law, and we recommend you consult with a registered tax agent.