Despite interest rates being low, debt stress is at record highs. Banking data shows that on average Principal and Interest repayments currently take up 42% of household income. As a result, banks are becoming concerned about what will happen when rates start to rise?
Increasing pressure from APRA and the Royal Commission, have made the ability to refinance loans considerably harder. Clients that have never had an issue obtaining a loan in the past are being heavily scrutinised and even having their applications declined.
Banks appetite for Interest Only loans have also decreased significantly. Many clients are finding that when they try to extend their Interest Only (I/O) term, that the banks are not accepting their request. If you have an investment property, paying principal and Interest (P&I) payments can have a significant impact on your cashflow and wealth strategies.
To make things worse, most banks have also changed the way they assess applicants ability to afford the loan (Serviceability). Instead of relying on an average living expense formula for couples and families, they are now wanting to see your personal bank statement transactions and a accurate budget.
If you’re like most people, you spend pretty much what comes in and your budget is set based on your bank balance. If interest rates went up you would just adjust your spending. Unfortunately, this type of budgeting is going to make it very tough when you apply for that next loan.
What can you do to prepare?
To ensure a smooth transition to Principal & Interest Repayments or rollover to another Interest Only period the following tips might help;
- Make a budget that proves you can afford P&I repayments with a 2% interest rate rise. Make sure its comprehensive, and don’t forget to include things like your drivers licence renewals and an amount for when your fridge blows or when you need to replace furniture. You might not need it this year, but next year you might.
- Stick to the budget. The banks review 6 months of transactions and if you broke the budget, they will know. An easy way to do this is by opening separate bank accounts for your discretionary spending. For example, Groceries, Gifts, leisure / entertainment, children, etc.
- Don’t leave it to the last minute to renew your Interest Only term. Speak to your broker or your bank, at least 3-6 months before the Interest Only term finishes. This will ensure that you have time to review your options and adjust your budget before you need to apply. It will also give you time to sell if affordability is an issue.
- If you do have to change to P&I, review the viability of your investment strategy. It may no longer be the best option, especially if you still have debt on your principal residence.
Puddle 2 Pond Financial is a Financial planner Nowra and has been in operation since 2012. We see clients at our office in Nowra and provide a mobile service in the Illawarra and Wollongong region. We specialise in helping clients with budgeting and implementing strategies so they stick to it. If you’re a little overwhelmed and would love some help, give us a call on 02 4424 0479 …. We’d love to help.