Cut Those Debts

Sydney Morning Herald

Saturday May 22, 1999

Annette Sampson Personal Finance Editor

If you're feeling vulnerable the time to talk to lenders is now - not when you're in deep trouble.

Here's a quick exercise. Tot up all your borrowings - the home loan, your credit cards, any investment borrowings, car leases, hire purchase agreements, the lot.

Then work out roughly what your repayment obligations are. It doesn't have to be exact. A ballpark figure will do, but, where the loan is on a principal and loan basis, be sure to include repayment of the principal that's been borrowed.

Now here's the $64 million question. How would you fare if interest rates started to rise? By 1 per cent? What about 3 per cent? Or even 5 or 6 per cent?

That's the question that has been raised this week with the reversal of interest rate expectations triggered by higher-than-expected inflation in the US.

National Australia Bank has already lifted its fixed loan rates, and with longer-term bond yields kicking up above 6 per cent on the news, it is only a matter of time before the rush begins.

Which raises two fundamental questions:

* How far and fast will rates go?

* And how much of a rise can borrowers bear?

The problem is that in the 1990s, household debt - the money you and I borrow as compared with governments or corporations - has been rising at a great pace.

Treasury estimates show household debt has risen from about 80 per cent of disposable income in 1994 to more than 100 per cent. The Reserve Bank says, household debt is worth $285.65 billion - or about $15,000 for every man, woman, and child.

At the same time, the household savings ratio has fallen - from about 12 per cent in the early 1980s to 0.8 per cent in December.

Who has been driving this gangbusters economy?

We have - by spending up big. Even if we are using other people's money.

The upshot of all this is that it is ordinary Australians who are most vulnerable to interest rate rises.

We haven't been borrowing stupidly - economists are quick to point out that low interest rates have made our debt more affordable and that household wealth has also been boosted by the booming sharemarket.

But these are justifications for the good times. As Access Economics pointed out a couple of months back, most household debt is structured at variable interest rates. This means rate rises hit households fast.

Access says low interest rates have made about 600,000 more people eligible to buy homes. But can all of these people sustain higher repayments if rates should rise? And remember, the family home is a non-income producing asset so it won't be able to help you fund higher loan repayments.

What about shares?

As we saw with sharemarket falls this week, increases in household wealth, when they are dependent on a continuing bull sharemarket, could turn out to be easy-come, easy-go. Analysts have been talking for some time about the giddy levels of share prices and calling for a dampener. When gurus such as US mutual fund king Warren Buffett start bemoaning a lack of well-priced shares to buy, it's fair to say the market is looking for an excuse for a breather.

An inflation kick-up in America doesn't mean the end of the world for Australian borrowers and investors. But the news should sound a warning bell. Now is the time to get your house in order.

The exercise at the start of this column is as good a starting point as any. Undertake a spot check on your finances. How exposed to debt are you? Where will the funds come from to service higher debt repayments? And do you have any "insurance" in place in case of the unexpected - losing your job, a significant sharemarket correction, or illness?

The growth in popularity of margin lending products and home equity loans being used to fund share purchases has created a new class of borrowers who could be hit by the double whammy of rising interest rates and falling share prices.

Also witness the growing number of home-owners who have redrawn on their loans - or extended them - to fund lifestyle purchases such as the new car, pool or overseas trip.

If you are at all vulnerable to an interest rate hike, advisers generally recommend reducing consumer debt first - the debt used to fund non-income producing assets.

It's also worth looking at high-cost debt. The Reserve Bank says Australians had more than $11 billion in advances outstanding on their credit cards in February. While there has been a growth in the number of people using their cards for convenience, and then paying them off in full at the end of the month, this is still a high-cost credit area which cries out for attention.

Card issuers already charging interest rates of about 15 per cent shouldn't be in any rush to lift rates higher. But there is little justification for consumers in paying these interest rates if they're trying to get their debt in order.

Some home-owners are already switching to a fixed-rate loan which can bring some certainty to the budget. However the advantages need to be weighed up against the drawback that you will generally be paying a higher rate now on loans for periods of more than one year.

And if you're feeling vulnerable, the time to talk to lenders is now - not when you're in deep trouble. Coming clean now might open up options to make repayments more manageable.

© 1999 Sydney Morning Herald

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