Financial stress is a major challenge faced by modern Australian households. What causes it? There are a range of economic forces that place households into financial stress, one of which is a high debt to income ratio for mortgage holders. At the time of the 2008 GFC, Australian households were at a 150-160 per cent debt to net disposable income ratio, which was similar to that of American households. Interest rates were also lowered by the RBA to historically low levels to encourage institutions and people to keep the flow of money going in Australia. This contributed to a spike in investor activity within the real estate market, a significant rise in property values, and an increase in interest-only loans being signed. Mix in some low wage growth and it is easy to see how many everyday homeowners have found themselves in a sticky situation.
Financial stress comes as a result of ballooning prices, or what some call a property bubble, as well as entering into legal arrangements without an understanding of the financial commitments, especially if and when the market changes. The definition of financial stress is where an individual or household struggles to meet basic financial commitments, such as mortgage repayments, living expenses, schooling etc. The Australian Bureau of Statistics views a household in financial stress if they fit four or more of the following indicators within a 12-month period:
Financial stress experiences
- Unable to raise $2000 in a week for something important
- Spend more money than received
- Could not pay gas, electricity or telephone bill on time
- Could not pay registration or insurance on time
- Pawned or sold something
- Went without meals
- Unable to heat home
- Sought assistance from welfare/community organisations
- Sought financial help from friends or family
Missing out experiences
- Could not afford a holiday for at least one week a year
- Could not afford a night out once a fortnight
- Could not afford friends of family over for a meal once a month
- Could not afford a special meal once a week
- Could only afford second hand clothes most of the time
- Could not afford leisure or hobby activities
Here are some key things to remember when researching and entering a loan to avoid getting yourself into financial stress:
Key aspects of a loan
1. Do you pay your ‘principal’ or just your ‘loan interest’? The preference for interest-only loans was chastened by the Australian Prudential Regulation Authority in 2017, who worked to apply stricter regulations on lenders. For this reason, you are less likely to be offered an interest-only loan by a lender or mortgage broker if you have less than a 20 per cent deposit, as well as extra finances available for the hidden costs of buying a home.
You may be encouraged to enter into an offset account. This is where you have a savings account that is linked to the home loan. The lender considers the money in that account effectively paid towards your loan, so they only charge you interest on your loan minus the hypothetical money you have paid towards it that sits in your offset account. This can be an effective way to buffer yourself against any jumps in interest rates or any unforeseen costs you face in your life (medical expenses etc.).
2. Be aware of what Lenders Mortgage Insurance means for the average home owner. Those who buy homes with less than a 20 per cent deposit will most likely need to take out LMI, which covers the lender (not the borrower) in case of the loan defaulting. Many new owners will do this and add the cost ($15,000-$20,000) to the value of their loan so they can enter the market sooner. While LMI can help people enter the market, it should not be relied upon by those who don’t have a secure financial situation, who are in debt for other expenses (credit cards) and who already struggle with everyday costs. These are people who may find themselves quickly in financial stress.
3. Fixed rate loans vs. variable rate loans often confuse those with little experience in the market. A fixed rate loan has an interest rate that will not change for a set period of time (usually 1,3 or 5 years) after which it becomes a variable rate. Some home owners face financial stress if they enter into fixed rate loans but struggle to make repayments when the loan becomes a variable rate. If you do enter a fixed rate loan, make sure you will be able to cover any cost increases once its term ends.
Variable rates change with the market, which means you can often end up paying higher interest rates then when you entered into the arrangement. However, you can also make extra repayments on variable home loans, while this may not be an option for those in fixed rate home loans.
Ways to avoid financial stress
1. Save a 20 per cent deposit for a home within your price range. This may be wishful thinking if you plan on buying within the inner-city area in Australia’s major markets, but if your financial situation isn’t rock solid then you either aren’t ready to buy a home or you should look further out for cheaper options.
2. Consider buying a home with friends to avoid financial stress. This is an increasingly popular option for new generations as well as those entering retirement. The former gains access to the market sooner, without putting them at financial risk, while the latter finds a support network and leaves themselves with more cash to fund their retirement.
3. Establish healthy savings practices. Split up your savings accounts into every day expenses, savings, emergency funds and your loan repayments. The amount you dedicate to each area depends on you and there are a range of financial advice books and blogs that can help you decide what suits your income and lifestyle the best. The point is that you know exactly how much money you have after your income is split up.
4. Avoid bad debt. Bad debt is that which doesn’t help you financially in the long run. If you buy a TV with a credit card, this is debt. Will you make money out of this purchase? If not, don’t buy it because it is money you never had.