Stress test your personal finance

The mass media is trumpeting about extremely high household debts in Australia and unfortunately, there are a lot of economic metrics which must raise major concerns to the government and to us as citizens and as an individuum.

Household debt relative to GDP. Source: Deloitte Access Economics, Bank for International Settlements

As per the Sydney Morning Herald, we are the most household indebted countries in the world and while the reasons behind that is not a focus of current post it is a good time to re-assess our personal financial condition.

The ABC suggests that National Debt Helpline is very hot from the thousands of calls from Australians missing on the mortgage payments and 30 per cent of Australian households are in some sort of financial stress.

As you know the interest rates are at record level low but they are not going to stay like this forever, they are going to rise and you better be ready for that.

The conventional wisdom is that you shouldn’t spend more than 30% of your income on your housing payments and not more than 40% on all the debts commitments. As this is not hard and fast rule you can stretch your limits to 50% of the income to pay for all your loans. This is calling Debt-to-income ratio which is calculated as monthly income/monthly loan payments.

Be realistic about your expenses, how much are your monthly spending? Are you going to have any major lump sum cost? Are you planning to have kids? Are you planning to go on holidays? Then work out how much money left and where you can cut on your expenses but I stress, be realistic! The amount of cash remaining will guide you on the size of mortgage you can comfortably handle. You can use ASIC mortgage calculator to find out the monthly repayments. Do not use the calculator for the current mortgage rate, as I’ve mentioned earlier at some stage it is going to increase, so have a look what your payments will be at least at 2% interest hike.

If you found yourself in a debt crisis don’t panic you have several options:

  1. Review your budget or make one of you don’t have yet. Cut on your expenses
  2. Get rid of the bad debt, especially the credit card debt. Pay it off and close your account, use the only debit card and leave by your means. Sell your new geared expensive car and buy with available cash the used one. Just focus on paying off all the bad debts that draining you down, starting from the ones with highest interest rates such as credit cards
  3. Increase your income, it can be full or part-time working partner or some freelancing, starting the family business, etc.
  4. Re-asses your mortgage. If after all you can’t effort your house then sell it and buy smaller and/or further away from the city.

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