Flight to safety

As consumer sentiment in the UK continues to decline, the mortgage market there is moving towards long-term, fixed-rate deals. Research quoted by Banking and Insurance Business Review indicates the proportion of fixed-rate mortgages on the UK market with terms over 10 years has almost doubled in the last 12 months. And as the current liquidity crisis continues, the number of available mortgages has plummeted by 41% overall, but long-term offerings have seen an increase from 127 available products to 137. According to MoneyExpert.com, the average initial rate payable on 25-year fixed-rate mortgages, at 6.56%, is notably lower than the market average of 6.9%, but still higher than last year's average of 6.38% for a comparable deal. MoneyExpert's director attributed the findings to "a flight to safety" by customers as a result of the credit crunch, and noted that both borrowers and lenders are currently keen on deals that offer certainty.

The Federal Government is conducting a review via a senate committee into the competitiveness of the home lending market here in Australia. One of the proposals put forward by the Melbourne Business School, and supported by the likes of David Liddy from Bank of Queensland and John Symmons from Aussie Mortgage Market, is for the establishment in Australia of an agency similar to Freddy Mac and Fannie Mae in the US, although the model they are proposing is more like that which operates in Canada which continues function normally despite current conditions. If adopted in Australia, one thing a funding model like this might be able to provide is longer term, fixed rate mortgages.

If they became available would you consider using fixed rate mortgages for terms of 20 or 30 years?

(references: Banking and Insurance Business Review, 31 July 2008)

Low-Doc Loans

Although some banks offer Lo Doc loans to PAYG earners, they are generally designed for self-employed customers who are not able to produce documents to substantiate their income. If you take out a low documentation loan, you won't need to give your lender as many documents to prove your income. You still have to apply in writing and sign your loan agreement, but you genrally are not be required to produce things like pay slips and tax returns. With most Low- Doc loans you are simply asked to state your income in a declaration know as “self-verification”.

Generally, any bank or other type of lender that offers these products will want to see proof of your assets and liabilities. In most cases they will attempt to make some comparison between the amount of income you are declaring and your asset position. If you are stating a very high income to service an expensive loan, a potential lender will expect to see a reasonably good net-asset position.

It's vital that you understand what you're getting into and not use a Low-Doc product to obtain a loan you simply otherwise couldn’t afford.

While some banks offer lo doc loans at rates equal to the prime lending rate (the rate offered to customers who fully verify their income), others charge a premium of around a half to one per cent higher. We are all familiar with the fact that banks have been increasing interest rates in advance of that levied by the Reserve Bank. Recently however, lenders have been moving the rate charged for Low-Doc products even higher. There are customers of several major banks who took out Low-Doc loans at near prime rates that are now being charged 10.50 per cent.

In wake of the recent wholesale funding difficulties (usually referred to as “the US sub-prime crisis) many lenders have withdrawn from the Low doc market. According to Cannex there were 180 Low-Doc loans being affered by46 lenders in January this year. This has shrunk to 153 loans from 38 lenders. Those that have exited include Bluestone, Virgin Money and big banks like HSBC and Macquarie.

The good news? Low-doc products made up 1 per cent of all loans in Australia last year, well below the 13 per cent that represent US sub-prime loans in that market.

(reference: smartcompany.com 30 July 2008; ASIC.gov.au)

How much can you borrow?

If you’re like most of us, buying a home is the biggest investment you will ever make. Since very few people are able pay cash, obtaining a loan is the foundation of home ownership. How much you borrow depends on a number of factors:

• Your income and expenses
• Estimated repayments
• Serviceability
• Assets and liabilities
• Your lifestyle
• Your deposit

Before you start looking for a home, think carefully about your spending habits. Compare expenses and income by preparing a budget noting all major upcoming expenses such as replacing your car, holidays, school fees, etc. Knowing exactly how much you spend each week is essential in determining how much you can afford to borrow. Having a realistic picture of your finances will avoid costly knock-backs from a potential lender.

Avoid being rejected for a loan. Lenders frequently trade credit information. A decision to decline a loan appears on you credit report and can harm your chances of obtaining a loan with another lender.

When deciding how much you can borrow, lenders will look at your serviceability - whether you can afford the repayments over the life of the loan, not just while interest rates are low. To do this, they use a benchmark figure that is usually several percentage points higher than the prevailing variable rate. Your repayments will also be assessed against your income. In most cases, the upper limit for minimum repayments is about 35 per cent of pre-tax income (or about 30 per cent of combined income for joint borrowers). Some lenders may use your uncommitted income - what is left over after all household expenses - to determine your repayment capacity.

In most cases, to be eligible for a loan you must own more than you owe. Lenders will look carefully at your existing assets and liabilities. Assets include furniture, jewellery, car, savings and investments that you may have built up over the years. Lenders will assess your credit risk to determine whether you are likely to default on the loan. Factors like your occupation, employment history, where you live and past loans are used to build a credit profile. Your credit risk can influence how much you can borrow.

Planning a budget

We have reached a point where we buy on impulse with no thoughts to the consequences. In order to reverse this trend we need to become more responsible with our spending habits. One of the best tools to help an individual accomplish this is the personal budget. Many people do not see the value in creating a budget as they simply have no desire to restrict their spending habits. However, budgeting is not about “financial dieting” but rather it is a decision-making process. While it is about numbers it is not about accounting. It is about making decisions in your life and choosing specific plans to make your goals a reality.

The object of a good budget is to make your money help you reach your goals, not to force you to conform to rigid rules. Don't be discouraged if your plan doesn't work for you right away. You may have to revise it several times until it fits your wants and needs.

Wants, needs and likes

Most of us would have heard of wants and needs and their importance in effective goal-setting. So often our financial ambitions are thwarted because we continue to choose to buy what we want and not what we need.

This is an important aspect of money management to be aware of. While our wants are very powerful motivators and can be central to the goals we aspire to, it is important to recognise that what you think you want may only be the things that you would just like.

The fundamental difference between the two is that you put your energy and effort into acquiring the things you want, while you just wish for the things you would like. To help understand the difference, look at your behavior and the energy you put into achieving some things but not others.

Some of the failure you may have experienced in achieving goal outcomes might be because you have set your goals on things you really only would like to have rather than those that you really want.