Mortgage rates peaked at 20.50 per cent per annum in June 1987. Since 1990 interest rates have been in a steady downtrend, with the last five years in particular, seeing rates in a band of 6.00% to just under 9.00%. Even within this range, folk are subject to significant cashflow pressure if they have not selected the correct debt facility, or are over-borrowed, and interest rates rise.
Household debt is at all time highs with a debt ratio of 140% of annual household disposable income as apposed to only 60% 15 years ago. Our love affair with debt continues.
Who owns your new shoes?
Here is the reality: we all use debt at some time in our lives. It is normal. In fact sometimes it is downright smart to do so. Of course, sometimes it isn't used so smartly.
Regardless of whether we are being smart about using debt or not, many people forget a really fundamental principle:
Your debt is somebody else's asset.
If you ever wanted a reason to get rid of debt then that is it. Your debt is someone else's asset..."they" own "it". "They" expect a return on that asset, and ideally they would like an income stream forever on their asset. The "someone" who owns the asset that you are paying off would probably prefer that you never paid it off. You are worth more to them while you stay in debt.
The thing that you used debt to purchase is only ever fully yours when there is no debt left. Whether that is a house, a business or a pair of shoes bought on a credit card: it is not yours until you have paid off the debt.
Reality check: you don't really own the new shoes bought on the credit card if you still owe money on the credit card. The bank owns the shoes.
I am not saying "don't use credit cards" or even "don't buy shoes". Both are pretty useful things to have.
What I am saying is understand the difference between you managing debt, or it managing you. If you aren't managing debt, then you are somebody else's asset.
Who wants to be someone else's asset?
Reverse Mortgages can help
Reverse mortgages (RM) are available to those retiree’s who are "asset wealthy and cash poor" with their house and a small amount of savings. Their only source of income is government super, of around $19,425 for a single person, or $29,184 for a couple, before tax. The result can be a cashflow shortfall to cover unexpected medical expenses, repairs and maintenance or just to maintain their standard of day to day living. This is where RM’s come in. They effectively allow the use of the stored home equity to fund these needs – and yet continue living in the house.
Debt is a four lettered word these days. Households are trying to get rid of it. Governments are effectively taking in more of it to try to save us from the excesses of households and of banks.
We should still not lose sight of the use of debt to invest however. Used in a measured way and understanding the risks debt can be useful.
Let us look at some very simple examples to demonstrate the power of debt, or leverage as it is often referred to. Let us say we have $1000 to invest and we choose an asset that produces cashflow of $100 per annum (with no growth). We have a 10% gross return on our capital ($100x100/$1000).
If we replace $500 of capital with $500 of bank borrowing for the same asset our gross return becomes 20% ($100x100/$500). We have the same cashflow but we are employing only half the capital to produce it so we double our return.
If only life were that simple! The bank of course wants to be paid. And it will attach a range of conditions to its lending. In the above example if the bank interest is 8% this gives a cost of $40 to service the debt. Our return on capital now becomes 12% ($500x100/($100 - $40).
The average American household holds 14.27 credit cards and card issuers mailed a record 5 billion card offers, according to research firm BAIGlobal.
How have we become swamped by this tsunami of debt? It seems it is not cool to: save and invest, start out in life with anything second hand or the latest wiz-bang technology? Why have the values of thrift of our predecessors been swept aside by this instant gratification. What has gotten into us? And, it is not only affecting Kiwi's.
The first step in finding a home is figuring out how much you can afford to spend. We’ll look at six different factors to consider when making this decision, with three of them related to mortgages, and the other three focused on broader personal considerations, such as how long you plan to own the home.
The mortgage is probably the biggest hassle facing prospective homeowners. The bank will want to ask you all sorts of nosey questions about your income and savings (or lack thereof), and then might not even lend you as much as you need. The nerve of them!
It seems clear that our consumption love affair means lower interest rates are a long way off. What does this means for mortgage holders – will the bank take away your umbrella just as the rain clouds gather. Fixing longer-term rates now, despite the lack of flexibility, is looking attractive.
The Reserve Bank left rates unchanged in December, however the Governor is clearly more hawkish than expected. Wholesale interest rates moved up, which influences the mortgage market.
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For most of us living a life without debt is almost impossible. Whether it is credit cards, student loans, or a mortgage, debt is just a part of life.
Nobody actually likes being in debt, but sometimes it is a smart move.
Certainly when it comes to investing in your education, or future ability to earn more money, debt can be very sensible. As it is with buying a house.
But what makes some debt good debt
A simple way to explain it is that it makes sense to borrow to buy an asset which will go up in value. Bad debt therefore is borrowing for anything which will decrease in value.
Good debt funds investments, or assets, that we otherwise could not afford to buy. It helps by creating leverage to purchase assets or investments that will help you become wealthier over time. Having said all that, it is worth investigating one type of debt a little further:
Research shows higher education leads to higher incomes, and degrees definitely add income for many. That in turn provides you with the chance to save and invest more than the average person, and increase wealth.
The problem is, there are many degrees and a lot of higher education provided today which does not lead to higher earnings. Some degrees just do not pay off by leading to better income earning jobs.
When it's good: If you have a clear career path with the potential to earn a lot of money and need to finance your higher education with loans. Just be sure to borrow only what you need and continue to save.
When it's bad: If your chosen career path will not generate significant income and you need to take out a bunch of loans to pay for your education.
Over the past decade the NZ Economy has been rolling along just fine.
The annual rate of growth is recorded at 3.75% and gross domestic product (GDP) outpacing the OECD 10 year average. Every where you look the news has been good. Interest rates are stable, wages rising modestly, the NZ dollar has been great for consumers (not so for exporters, sorry), stock markets have performed well and employment is at 20 year highs.