Thursday, November 4, 2010

Mortgage rate rises causing mortgage arrears

Loan defaults have been increasing
The last six rate rate rises in Australia has resulted in increasing loan defaults. Unlike our overseas counterparts, our average home loans are around the $300,000 amount. Here's an extract from the
Real Estate Institute of Queensland managing director Dan Molloy said the August spike showed the typical lag between rate rises and the impact on homeowners.

"The series of six interest rate increases in the period from October last year to May this year has had a dramatic and tragic impact on some people," he said. "The cumulative effect of those adding up to $300 a month on the average $300,000 mortgage obviously was too much for some people and the financial institutions moved."

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Imagine trying to find an extra $300 each month when you've been living a pretty bare existence already. When you've been living paycheck to paycheck just barely meeting mortgage payments.

A multitude of circumstances and unfortunate events may have resulted in people's inability to meet their mortgage payments: poor health, injury, sickness, loss of job/jobs, cut in hours, unexpected bills and expenses and a gazillion other reasons that I have not listed.

There are a few steps that you could take to ensure that you minimise the risk of mortgage defaults and being in arrear on your mortgage.

If you have a mortgage already:

* Ensure you build up an emergency fund(EF) to cover mortgages, bills and expenses (with extra to cover for unexpected expenses like your car breaking down suddenly) for the duration that it may take you to find a new job if you are unexpectedly unemployed. If you're in a tough industry and it may take 1 year to find work, then your EF should cover 1 years worth of expenses

* Have funds in a separate saving account or in liquid (easy to convert to cash) investments that can meet your mortgage payments for the duration that you are job hunting and not earning an income. This ensures that you will not fall into arrear and will not be paying extra costs for defaults and cheques bouncing and incurring overdrafts.

* If your account doesn't allow you to withdraw your extra repayments, it is really important to ensure that you have separate savings instead of ploughing extra money directly into paying off your mortgage. If you're in Australia, it's preferable to setup a separate offset account so that you can deposit any extra funds you've got into it rather than directly into your mortgage. With an offset account, it doesn't matter whether you're employed or unemployed, you can always make withdrawals. The terms of some mortgages specify that if someone is unemployed, they cannot withdraw their extra repayments. This is an important restrictive condition to watch out for.

* Make sure you have backup plans in the event that you lose your income

* If you're serious about building your wealth and obtaining financial freedom, you should avoid refinancing your mortgage to buy trivial depreciating goods such as boats, cars and holidays.

If you haven't got a mortgage but are planning to buy:

* Form a budget so you know what all your expense are and how much you can afford each month. If after you know what your income and expenses are and you can allocate $1500/month towards a mortgage for example, then pretend you have a mortgage to pay and ensure that you can easily save that $1500/month. Maintain this for a few months to see whether you can cope with that level of repayment.

* Don't borrow the maximum the bank approves you to borrow. I can't stress that point enough. The bank will always be keen to loan you more than you're comfortable with repaying and in many recent mortgage defaults, more than they can afford to repay after a few interest rate rises. Just because the bank approves a $500,000 loan, doesn't mean you should go out and buy a $500,000 house if all you need for you (and your family) is a $350,000 house for example.

* Always buy your first house with a 20% deposit at least. That way you don't have to pay LMI (Lender Mortgage Insurance) and it demonstrates to yourself (and the bank of course) that you can save something. If you're a risk taker, you can always buy with no deposit but if you can't even save some amount for a deposit, what makes you think that you can pay your mortgage regularly without falling into arrears?

* The exception to the rule: If you pay rent without any problems every week or month, as long as your mortgage payments are roughly equivalent to your rental payments, then you're more likely to beable to buy even without a deposit. Although, being a home owner does come with additional expenses such as repairs and maintenance - expenses which you previously didn't have to pay for, when you were renting.

Buying a property means having to do some serious number crunching and risk analysis. Always factor in the risk that interest rates will increase. The risk that you will have to do repairs and maintenance on your place. The risk that something will break down or leak. The risk that if you are buying an investment property, you may have difficulty finding renters and tenants. The risk that your expected cash flows may not materialise. The risk that you may become unemployed or experience a drop in income.

As they say, the plans could go awry, but having a plan is always better than no plan.

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