It is time to budget and save!

It is almost Christmas again. Are you going to buy a lot of gifts and max out the credit card this year? or are you going to be wise about buying gifts and stretch the dollar? In previous years, it is common to see that we love to spend money buying gifts for loved ones and we will deal with the credit card bill later. So I think that it will be interesting to see if in the New Year, 2010, will our spending habits be the same as previous years or have we been wiser?

Personal Budgeting and Personal Savings is not a new idea. I learnt about this when I was very young. I was given a money tin to put some of my pocket money in it. I believe that we have been exposed to this concept in some way or another. However everyone has a different view point in how important this concept should be.

It is only human for us to spend but with the ease of obtaining credit cards we could get ourselves into a lot of financial trouble. We are a spending nation and we love to shop. We shop because we need things like food, shelter and clothing; we also shop because we want things like play station, Wii, bigger car, bigger house, electronic gadgets, jewellery etc. However, are we shopping for appreciable assets like properties, shares and collectible items like art and antiques?

So why is savings so important? We save so that should the need arises; we can use our savings at a later date. The older we get, the more we will think about lifestyle in retirement years. With writers like Robert Kiyosaki, we are seeing younger people getting out of the "rat race". Mr Kiyosaki speaks about investing well and building businesses that will provide you with positive or passive income. However with most of us, we will have to start with an active income, IE our jobs. Once we have saved sufficient sums of cash, we can then invest our money to either buy or invest in a business or shares which in turn should give us passive income. The keyword here is should. I do not have crystal ball and therefore I cannot predict what will happen next year let alone tomorrow.

Why is this viewpoint important? This is important because we currently live in an economy with relatively low interest rate. We have a job (assuming that we are employed) and we pay our bills. What happens if we took the path of buying properties with debt, some might even call it good debt, or buy shares and borrow against it? If there is a small change in the interest rate, depending on the amount borrowed, the increase in accrued interest rate payable to the lender could be substantial. Let’s take a small example of a 30 year home loan of $400,000 at 5% interest rate per annum. Interest is calculated on a daily balance and charged at the end of the month. The monthly repayment to ensure the loan is amortised over 30 years would be $2,147.29. If the interest rate were to rise by 0.25% the repayment will increase to $2,208.81, that’s a $61.52 increase per month. Now let’s project a 1.00% rate rise. This will increase the monthly repayment to $2,398.20 or $250.91 per month extra that we will have to pay for the privilege of owning a home with a mortgage.

Again assuming that we are still working, our wages will not increase at the same rate as that of the reserve bank. Therefore with any increase in the official interest rate, if we had budgeted for this, we should be well prepared. However, those who are not ready for this increase, may have to find a second job to make ends meet.

The key to this is budget within our means and not outside our means. Spend within our means. Do not spend more than we earn and do not spend on things that we do not have the funds for. It is easy to say that I will get paid tomorrow or there will be a tax refund cheque coming. What is important is that it is not in your hands at this moment.

Savings is an important key. If our capacity is only to save 10% of our income, then so be it. If we cannot save 10% of our income, then try a smaller amount such that you will not feel it and progressively move to a higher amount. Remember, savings is a discipline, however once you get the hang of it; it will be with you for life.

Another Drop in Interest Rates

Well the Reserve Bank of Australia has today, 2nd December 2008 announced a reduction in interest rates by a further 1.00% or 100 basis points which now makes the cash rate to be 4.25%.

It will be very interesting to see if the Australian banks and Money Managers or originators will follow suit. I am seeing more clients now breaking their fixed rate loan which they had applied for early in the year to enable saving their interest cost. To break your fixed rate loan today if it has not expired will certainly trigger economic costs to the borrower. Economic cost is where the banks will change the borrower for early termination of the loan.

So is it worth breaking, well you will need to do the sums. Generally those that have a fixed rate and would like to break the loan to get a cheaper rate should work out the benefit of when you will recover the economic costs. Take the difference of interest rate and the savings in dollars and divide this with the cost to break your loan. For example, if your break cost is $5,000 and you have a fixed rate loan of $400,000 at 10.00% and the fixed rate is now 6.50%, this would be a savings of 3.50% of interest. Working on interest savings only, this will mean that you will save approximately $14,000 per year in interest or $1,166 per month in interest. With $1,166 per month, you will be in front with just over 4 months by breaking your loan. If the break cost is $10,000 then it will be just under 9 months.

So those of you with high interest rates which was locked early in the year, you should now speak with your mortgage broker and get them to find you the best rate. Alternatively, go to www.myhomeloansbroker.com.au and we will assign a mortgage broker to you.

Fixed Interest Rates going down

CBA has today reduced their fixed interest rates. What does this mean? In short, CBA economists believe that official interest rates will most probably go down and therefore they can pass this on. This is good news for consumers but .... will it last?

Let's see how far down both the variable and fixed rates will go and see the reversed of how high and when the rates will go.

Again, if you are asking should I therefore be fixing now, please read my previous blog, to fix or not to fix.

Mortgage Broker under attack

Have you seen any reports about mortgage brokers doing the RIGHT thing? In fact, it would appear that the media loves to report on negative experiences with mortgage brokers.

This year, we have seen consumers becoming more aware of products and services offered by mortgage brokers because of the credit crunch in the US and bad practices of mortgage brokers in the US. It was very common in the US for mortgage brokers to write loans for consumers who do not qualify for normal market rates. Over here in Australia, most home loans are securitised which means that they are generally conforming loans and have a lower probability of default.

"Brokers were once again subject to negative press over the weekend with Herald Sun columnist Scott Pape telling consumers to “steer clear” of brokers and their “expensive” products" as quoted in today's Breaking News section of Mortgage Business article (http://www.mortgagebusiness.com.au/index.php?option=com_content&task=view&id=1368&Itemid=37).

Mr Pape’s advice stemmed from a recent Choice report which claimed borrowers could save thousands by avoiding brokers – but failed to acknowledge the real role that mortgage brokers play.

Yes I would agree with Mr Pape that there are mortgage brokers out there that have had other interests in mind, eg: looking after their own back pockets by choosing the lender that pays higher commission or even asking for a fee over and above the commission from the lender. But these are the minority of mortgage brokers which does not make ALL mortgage brokers bad.

Let's talk about how a good mortgage broker looks like:

• A good mortgage broker will usually come with good references from past clients.
• On making contact with a potential client, the mortgage broker will have set a rapport with the client and then set a mutual time to either visit them at their home or an alternative venue.
  

• During the interview process, notes will be taken by the broker to capture the scenario of the loan applicant. There are generally 4 C's associated with this:

1. Capital (deposit/savings)
2. Character (of the applicant)
   
3. Capacity (the serviceability of the loan repayment)
   
4. Capability (ability to maintain the capacity)

• Following the interview process, the broker should have gathered sufficient information to search for the most suitable product(s) based on the client's requirement.
• The broker will generally present 2-3 options to the client taking care to explain the advantages and disadvantages of each product.
• Upon selection of the product of choice by the client, the broker will lodge the completed application with all supporting documentation to the lender.
• The client is advised about each step of the process ensuring a smooth settlement.
• A good broker would have removed a lot of the complexity of the process away from the client.
  

I firmly believe that the consumer will need to do their home work and ask all the relevant questions to their mortgage broker. Also, it is important that consumers trust their mortgage broker and will provide, in confidence, information that will assist with the application process. Without this trust, it is a hit-and-miss type application and the mortgage broker can only describe the scenario to the lender as per the information available.

By the way, most mortgage brokers are paid by the lenders and will not require additional commissions. However please note, for some cases, especially the more difficult and complicated loans, the broker may charge a reasonable fee. This of course is negotiable with your mortgage broker.

There are a lot more stories of how mortgage brokers have saved their clients money and time. Where are the writers of such stories? Can it be that there are only bad stories out there? Mortgage brokers like any professional service, if used wisely can save the consumer a lot of time, money and help the consumer gain a lot more insights about a loan that they would otherwise just follow what a banker might introduce. There are over 30 lenders in Australia and over 3000 loan products. I do not dare to count as products are changed regularly by each lender. So how can a consumer or borrower find the right product for them if they do not have the time to do research? Hence the mortgage broker.

A lot of mortgage brokers were once a point a time, a banker. Regardless of whether the mortgage broker was a banker or not, all mortgage brokers have to comply with Commonwealth and State laws. Some of these compliance will require the mortgage broker to pass courses in Anti Money Laundry, Certificate IV in Mortgage Brokering, accreditation with the respective lenders, a clear police report, a clean credit report and on-going professional days. If you think that it is easy to be a mortgage broker, think again. The amount of paper work, courses, memberships and not forgetting the costs (telecommunications, marketing, print materials, corporate image, office equipment, back-end support, insurance etc), that a broker is required to incur are enough to turn someone off from being a mortgage broker.

So now knowing that it is not as easy to be a mortgage broker, what steps could I take to find a GOOD mortgage broker? The easiest is to ask your friends who they had used. Once you have made the appointment with the mortgage broker continue to ask questions. Questions like:

• how long have you been brokering?
• what background do you have?
  
• have you written loans similar to my scenario?
• what type of clients do you look after or prefer to see?
• what are your commission structure?
• do I have to pay for your services?
• are you a member of a professional body like MFAA or FBAA?
• are you a member of the credit ombudsman office?
• do you hold professional indemnity insurance? and so on
  

The above are just some of the questions what you should ask your broker, and if at any time you are uncomfortable with the answer or if the mortgage broker is not able to answer them, then walk away.

Seeing a mortgage broker is like seeing a specialist. Would you go and see the dentist if you had a heart attack? Mortgage brokers are specialist in the mortgage field. They are not insurance or real estate specialist, they are specialist in mortgages. Do not ask them about real estate or even insurance. If they are going to comment on other topics besides mortgages, then ask them for their credentials. At the end of the day, ask yourself a question, who are you seeing? A mortgage broker or a financial adviser?

Now on the other hand, have you had a bad experience with a broker? If so did you report it? and who did you report it to? If you did not report the broker, what is the reason you did not report it? There are many organizations to which you can report the particular mortgage broker.

• the lender, IE the bank that the broker referred you to
• the credit ombudsmen office, COSL
• the aggregation company which the broker is linked to
  
• the professional body who monitors brokers, like MFAA or FBAA

As consumers, we must all take the time to advise the relevant authorities so that the unprofessional mortgage broker can be taken off the list of professional mortgage brokers. We should strive for a regulated industry so that everyone can have the best possible experience of a professional mortgage broker.

To Fix or Not to Fix my Interest Rate

On Melbourne Cup Day, 4th November 2008, the Reserve Bank of Australia reduced the official cash rate from 6.00% to 5.25% which is a 75 basis points decrease. With the ever growing concern about what is going to happen tomorrow, borrowers should start to ask the question if fixing their interest rate now is worth doing or wait for further interest rate drops.

I have been hearing in the news about doom and gloom scenarios, about companies restructuring under the current economic pressures, investigation of companies and their board, share prices going down, super funds not allowing withdrawals (especially funds linked to mortgage funds) and job losses. These sort of reports from the media do not really give confidence that there is light at the end of the tunnel. However I am sure that there is indeed light at the end of the tunnel, it is just a little dim right now. To quote an ancient proverb, "To everything there is a season, A time for every purpose under heaven".

A number of my clients have asked me the question, should they fix their interest rates on their home loans or leave it as variable. Hence the topic, "To fix or not to fix". Well, the answer is not that simple and you the borrower will need to evaluate your current situation, and lifestyle.

You might ask, what has my current lifestyle got to do with fixing the rate? Simple. Do you have a budget? If so, are you sticking to it? Have you been able to stick to it? If your answers are Yes, then keeping the rate type as variable and riding the interest wave should not affect you. However if you had answered No to one or more of the questions above, then you might want to consider the security of fixing your interest rate, IE knowing how much you need to pay your loan every month.

The above is simply "living within your means". I have noticed that clients who keep to a budget also have goals. They are driven by the same set rules to minimise their loans or get it under control as soon as possible. This drive has earned them "reward points" or "reward dollars", like the ability to redraw from their current loan or to utilise their savings to purchase another property. The power of reducing your mortgage is the ability to budget well and be disciplined at it.

So what has this to do with variable or fixed rates you might ask. Well let's just explore this. In good times, do we save? or do we spend? If we start with an income of say $50,000 per annum, we would generally spend up to (hopefully) $50,000 and not more. So what happens when our income increases to $60,000 per annum? Do we spend just $50,000 and save the $10,000 or do we now spend $60,000?

Again, it is relatively simple. Are you living within your means? Have you a safety net in the event that you might need to live off your savings for a while? Everyone is different and understanding where you are at right now might provide you with the answer of fixing or not.

Ok so let's talk about lifestyle. Now everyone has their own "style". There is no right or wrong to this but you will need to balance this out with income and expenses. Income is the money that you earn, whether it is a business or salary, rental or interest, they are all income. Expenses are all the cost that is associated with living, for example food, entertainment, insurance, motor vehicle running costs, going to work every day, all monies going out are known as expenses. So the question of lifestyle is simple, where is your money being spent? Are you saving enough, are you paying off your debts (and not increasing them) and are you living well?

I have heard some people call it the 1/3, 1/3, 1/3 rule. 1/3 is utilised for living expenses, 1/3 is used for savings, and the final 1/3 is used for paying off debts. Where are you in regards to this? Also in good times, some of us will have spouses who can help reduce the mortgage quicker. Are you using this additional income to pay off the mortgage or are you spending this additional income because you can, because it is there?

Hence it is very important to know where we are at with our lives and are we living within our means. Things that need to be considered would be:

1. what if my income were reduced
2. what if I lose my job
3. what if my spouse stops working
4. what if interest rate increases
5. the same question could be asked, if interest rate were to decrease

The above are just a few questions that we need to ask of ourselves. Are we prepared for it?

There are some disadvantages in fixing your interest rates. Here are just some of them:

1. in a market whereby interest rates are falling, locking the interest rate might see you pay more in interest.
2. when you want to get out of your loan for whatever reason, for example whether you would like to sell your property or just refinance your loan, if you are in a fixed rate period, there might be penalties imposed on the loan.
3. if you need additional funds and you managed to deposit the additional funds into your fixed rate loan, you might not be able to redraw the additional funds.
4. some lenders will not allow you to deposit more funds into your loan without charging you a fee for doing so.

The best person that can decide if it is better to fix or not to fix the interest rate would be yourself. Your mortgage broker will be able to help you explore and weigh out advantages and disadvantages in fixing your interest rate.