Credit When It's Due

Sydney Morning Herald

Saturday February 26, 2005

Annette Sampson

Big spenders who have taken advantage of the low interest rates of recent years are about to feel some pain in the hip pocket, writes Annette Sampson.

WHILE businesses and governments have been reducing their borrowings in recent years, Australia's consumers have been on a debt binge. Since the mid-1990s, we've been spending more than we earn. Household debt has risen from 50 per cent of annual disposable income in 1990 to 140 per cent today. This means that while the average family would have needed to direct every cent it had to debt reduction for a year to be debt-free, it would now take more than two years.

To many, that's not a problem. The rise in debt, after all, has come on the back of rising wages and higher levels of wealth for many Australians - largely due to soaring house prices.

But just as overgeared businesses were vulnerable to interest rate rises in the late '80s, highly geared consumers will bear the brunt of further rate rises.

In the late '80s, when interest rates were 17 to 18 per cent and the economy was sent into recession, the average household was using 7.9 per cent of its disposable income to service its debts. Now, with interest rates at less than half what they were, the Reserve Bank says this debt-servicing ratio is at a record 9.3 per cent.

As Craig James, chief economist with CommSec, says, households are now so highly leveraged that it would not take a return to 17 per cent interest rates to cause havoc in the mortgage belt. A relatively modest rise of just two percentage points would drive the economy into recession and send house prices through the floor.

Fortunately, he believes, rates won't rise by anything near this level. But, just as the wider economy needs reform, rising interest rates are a signal that the glory days of big spending and cheap debt are drawing to a close.

There are signs consumers are already reining in their spending and debts. Personal debt fell by 5 per cent last year and James says the proportion of credit card debt accruing interest stabilised mid-last year. "That means people have started getting their spending and debts in order."

But the finances of the average household are much more complicated than they were a decade ago.

Linda Sterling-Levis, a co-ordinator with the Christian Community Aid Financial Counselling Service in West Ryde, says households experiencing financial problems typically have a number of debts - his-and-hers credit cards, various consumer loans and different types of home loans. The increased complexity makes it more difficult to identify and solve problems before they get too big.

Sterling-Levis says there was a significant increase in people seeking financial help after the last round of interest rate rises, and fears something similar will happen after the next increase. "Consumers should be working out if they can afford higher interest rates now," she says.

While the first rate increase is likely to be small - a quarter of a percentage point - that's unlikely to be the end of it, and she says consumers need to consider how they'd cope with a couple of rate rises and set aside the money now.

While much of the attention is focused on the mortgage belt, it is not mortgage debt that has the experts worried. James says a high proportion of home loan borrowers have been making extra repayments on their loans and have a buffer built into their repayments. As an indication, the Commonwealth Bank says about half its customers are ahead with their home loan repayments.

Andrew Willink, managing director of the research firm Cannex, says people who can't afford a couple of rate rises could consider locking in a fixed-rate loan. Lenders are pushing this option, touting the fact that fixed rates are still below 7 per cent. But Willink warns the costs incurred don't justify the switch for many borrowers.

The general manager of Infochoice, Denis Orrock, says anyone considering a fixed rate should make sure the rate they're offered today is the one they will get when the loan is settled. Some lenders will lock in the present rate, for a fee. But Orrock believes consumers will find the next rate rise tougher than the previous two because of the explosion in personal, rather than mortgage, debt.

One unknown is the extent to which consumers have been using products such as home equity loans and redraw facilities to fund consumption. While the Reserve Bank is surveying up to 10,000 households on their use of housing finance for other purposes, Orrock says Infochoice research has found 40 per cent of borrowers have withdrawn equity from their homes to spend on consumer goods. "Those people should be trying to restore equity in their homes as soon as possible."

Orrock also believes the growth in credit card debt has made consumers more vulnerable to the next rate rise than to the last couple of rises. "People strive to keep ahead on their mortgage debt, which costs the least, but are happy to carry credit card debt where they're paying 9.5 to 19 per cent."

Willink says competition in the credit card market, and the proliferation of low- or zero-interest offers for customers who transfer their balances to a new card, present an opportunity for borrowers to consolidate their credit card debts and make a concerted effort to pay them off. But this will only work if they curb their spending and keep the debt under control.

WHAT TO DO PREPARING FOR HIGHER INTEREST RATES

Mortgages

* Increase repayments as a buffer against further rate rises.

* Consider fixing for certainty.

* Consider refinancing if your rate is high.

Home equity loans

* If you've borrowed to consume, step up your repayments so those borrowings are paid off faster.

* Refinance to a cheaper loan if you don't need a line of credit.

Investment loans

* Plan cashflow to meet higher repayments.

* Review investments not generating adequate returns or income.

Credit cards

* Direct extra cash to reducing your outstanding account balance. It is the most expensive debt most people have.

* Consider switching to a card with a lower interest rate.

* Zero-interest offers on new cards present an opportunity to consolidate your debts and pay them off faster - so long as you rein in future spending.

Savings

* Term deposit rates may present opportunities to lock in a higher rate after a rate rise.

* Keep an eye on interest rates as your account may not receive the full interest rate rise.

* Shop around for the best rate - high-interest online savings accounts can match, or even better, the official cash rate while keeping your money at call.

Investments

* Review yield-based investments that may suffer from higher rates.

© 2005 Sydney Morning Herald

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