Crunch Your Credit

A line of credit, or revolving credit, is a very useful facility to have as part of your mortgage structure. The way it works is that you are committed to pay back only the interest each month and interest is charged only on the amount borrowed. Repayments of principal can be made at any time without penalty and the more you repay, the less interest you pay.

One key advantage of a line of credit is that if you run short of funds you can spend or withdraw up to the limit that has been set. This means that you can pay all your spare cash into your line of credit to keep the balance and the interest down, knowing you can grab it back at any time. If you have a mortgage, the best return you can get for your emergency savings is to ‘invest’ it in a line of credit. The return you get will be the interest you save on your borrowing.

Some mortgage brokers and lenders advocate using a line of credit as a transaction account for receiving income and paying all your living expenses. In theory, this will ensure your loan balance is kept as low as possible. In practice, this system usually fails because unless you are very disciplined it becomes almost impossible to keep to a budget. It is better to instead make a regular payment each payday into your line of credit to reduce the balance.

Some banks are now offering customers the ability to offset balances in a range of accounts, which is a great way to keep your savings separate from your mortgage. You will only pay or earn interest on the net balance of the range of accounts. The more you save, the more you will crunch your credit!

Letting Go

The end of a long term relationship is a traumatic event even when the end is by mutual agreement. Unfortunately, failed relationships are becoming increasingly common.

As well as the emotional turmoil, there are huge financial implications to come to terms with and the prospect of dealing with these issues sometimes leads people to stay in relationships that don’t work.

For couples who are newly separated, one of the major issues to deal with is what should happen to the family home, particularly when there are young children involved. At a time of emotional instability, the family home is a safe haven. It is enough to deal with a relationship breakdown, let alone adding a house move into the picture.

There are a number of reasons why it makes good sense to divide relationship property as quickly as possible after the end of a relationship. A clean break allows both parties to move forward both emotionally and financially and is less complicated.

Retaining the family home in joint names means both parties are entitled to have access to the property and existing mortgage arrangements can potentially be used for the benefit of one partner but with both partners still being liable for the debt.

The burden for one partner of taking over the ownership can be made easier by taking in a boarder, getting financial help from family members, taking out an interest only mortgage, extending the term of the mortgage or taking a mortgage repayment holiday for a few months. Often it is best to sell rather than live in financial difficulty.

This is not necessarily a bad thing. Property prices are not expected to increase markedly in the medium term and renting for a while gives some breathing space to create a stable financial base from which to move forward again.

When Things go Wrong

There’s an old saying – ‘the higher you go, the harder you fall’. If you are following a strategy to build your wealth quickly, you have a much higher risk of things going wrong and potentially of losing everything. Risk and return go together, so unless you are prepared to take a chance or two your wealth will grow only slowly.

Safe and secure works for some people, but others are impatient and have big plans. Neither approach is wrong; it’s what is right for you that counts and everybody has a different view about what is right for them. True entrepreneurs often go through cycles of making and losing money. Take Donald Trump and Robert Kyosaki for example. Both have been bankrupt at least once in their lives.

What distinguishes entrepreneurs from the average person is their ability to start creating wealth quickly again even though they have lost everything. It is a skill developed from confidence in their own ability and an optimistic belief that opportunities are unlimited in number and just waiting to be found. The number of truly successful entrepreneurs is a small but highly visible percentage of the total population.

They are great role models for the rest of us, however there is a danger in that the ‘wannabe’ entrepreneurs who have the desire to create wealth but not necessarily the skills sometimes find themselves in trouble. It’s a bit like watching stunt performers on television with the message ‘don’t try this at home’. Sometimes people take risks that can lead to great success if you have the right skill set and dismal failure if you don’t. Having the insight to know your own limitations and when you need to call on expert help is a key ingredient for successful entrepreneurship.

Being able to successfully manage high levels of debt is one of the areas that sorts out the true entrepreneurs from the ‘wannabes’. One of the quickest ways to grow wealth is to use Other People’s Money; that is to borrow from a financial institution or personal contact for the purpose of investing in property and business ventures. This is a strategy that works well if the returns on the investment are greater than the cost of borrowing.

The problem is that sometimes the returns are only apparent in the long term, whereas loan repayments must be made on a regular basis in the short term. If the amount of cash coming in from the investments is less than the cash going out to cover loan repayments and other expenses then, unless the investor has other funds available (either savings or other income), the outcome is failure. The higher the level of debt, the more cash you need coming in, and the more vulnerable you are to unexpected changes such as economic recession, loss of tenants or customers, ill health and redundancy.

Sometimes the best strategy is to clear the decks and start over again. That means selling off assets such as property and businesses and using the proceeds to pay off debt. Stabilising your financial situation gives you the opportunity to start growing again with the wisdom from lessons learned that will help you succeed.

The Ethics of Debt

With every economic crisis the first to suffer financially are usually those whose situation has been weakened by debt. Low levels of debt provide immunity to adverse conditions so that personal financial crisis can be averted.

Taking on debt is a bit like taking laxatives – a small amount makes life go more smoothly, but too much can leave you in the proverbial! The best way to avoid an overdose of debt is to start out in life without it.

There are many instances of young people loading themselves up with debt as soon as they start their working life on the premise that future earnings will pay for their present lifestyle. Generation Y are comfortable with debt because of their optimistic outlook on life and blissful ignorance of the consequences of paying interest on money borrowed.

I was impressed however, to be told recently by an eighteen year old keen to buy her first car that she wants to save up for it rather than get a loan because she doesn’t want to be in debt for the rest of her life! Buying a first car using borrowed funds can indeed be the end of a debt free life. By the time the loan is repaid, the car has dropped in value and needs replacing. Making loan repayments means it is hard to save and so more money needs to be borrowed to buy another car. It’s the start of a vicious cycle of debt that indeed can last a lifetime. Over that lifetime the interest paid on funds borrowed would be enough to buy any eighteen year-old a dream car.

It is not only the interest on debt that creates a problem; it is also the fact that debt imposes a commitment to pay that must be honoured regardless of your financial circumstances.

Debt repayment is not something that can be done only when you have funds to spare. By contrast, if you start regular savings for something you want to buy rather than going into debt, you can cut back on your savings if money becomes tight.

Economists analysing the current economic crisis are of the view that high levels of personal debt in the world’s major economies are at the root of our present troubles. Debt has weakened our resilience to economic shocks and unpaid debts have ultimately led to the demise of what were once rock solid financial institutions.

Who is to blame for this sad situation?

We have a society that ranks people by the number and quality of their material possessions, an impatient generation that lives beyond its means and lenders who have greedily spotted an opportunity to increase profits by dishing out debt to those who can least afford it.

The result is a growing class of people who are victims of debt, trapped by high levels of financial commitment that make it impossible to save and get ahead, and suffering extreme psychological as well as financial stress.

Whatever happened to social responsibility?

While individuals choose to take on debt, society has a role to protect those who are vulnerable to pressure from peers and the temptations of easy credit.

Legislation and regulation can offer some protection, but it is ethical behaviour on the part of lenders that will provide the solution.

Mortgage Holidays a Last Resort

One of the biggest expenses in most household budgets is mortgage repayment, especially for young couples who have scraped together the minimum deposit to buy a house.

A big mortgage usually means a high level of financial commitment that leaves little room for saving. Without saving, unplanned expenses or unplanned loss of income can mean the difference between struggling by and financial crisis.

In the current economic climate, loss of income is a real possibility as businesses and Government Departments shed staff. When times are hard, a mortgage holiday can provide welcome relief.

Most banks have had a policy of offering mortgage holidays to people struggling to meet payments. Don’t think, however, that banks are motivated to do this purely out of kindness towards their customers.

Of course, there is an element of good will, but mortgage holidays are a good way for banks to avoid the expense of having to manage a customer who is behind on payments or, at worst, having to arrange a mortgagee sale.

They are also a way for banks to make more money, because throughout the period of the mortgage holiday interest on the mortgage keeps on compounding.

A mortgage holiday may be a good short term solution when money is tight, but in the long term it means that more interest is paid and the mortgage takes longer to be paid off in full.

Prevention is always better than cure and when you are taking on debt, don’t commit yourself to the extent that you have no room for saving.

Sometimes it is not the mortgage that is the problem but credit card and store card debt that gets out of control after the mortgage has been taken up.

Keep a lid on your commitments and make sure you have an emergency fund to tide you over when unexpected things happen.

If you have a change in circumstances, take action sooner rather than later. Review your budget and be prepared to let go of things that are costing you money and which you can do without until the bad times are over.

You should consider a mortgage holiday if

• You have reviewed your budget and still can’t make ends meet
• You have a large amount of credit or store card debt that is increasing because you can’t keep up the payments
• You are suffering from stress due to financial worries
• You feel confident that at the end of the mortgage holiday you will be able to keep up with your financial commitments.

Once you have arranged the mortgage holiday, use the spare funds to pay off any other debts you might have and, if there is anything left over, keep it on hand to cover unexpected expenses.

Whatever you do, don’t take a mortgage holiday so that you can spend more.

A mortgage holiday is a good way to avoid a financial crisis, but it comes at a cost and should be considered as a last resort.