The Big Squeeze

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There is no doubt we at the start of a new economic cycle with higher interest rates and higher inflation. Without a corresponding increase in income, many families will feel a big squeeze – that is a significant increase in living costs which can easily lead to out of control debt. Budget pressures are only going to get worse. Now is the time to plan ahead for rising costs and to get budgets under much tighter control. Wake up New Zealand, it is time to curb spending! We have had it too good for too long. Rapidly increasing property prices and low interest rates have led us all to believe that we are wealthy enough to borrow and spend more. However, the good times are well and truly over.

If you were lucky enough to borrow $800,000 to buy your dream home when interest rates were around 2% your fortnightly payments over 30 years would be about $1,365. At a 5% interest rate, which we are rapidly heading towards, repayments will be $1,982 per fortnight. That’s an increase of $617 per fortnight or just over $16,000 a year. At a marginal tax rate of 30% you would need to earn around $23,000 a year more to cover this increased cost.

The pain will start to kick in as mortgage interest rates start to come up for renewal. If your mortgage is still fixed at a low rate, you have time to plan ahead for the change. Now is the time to think ahead as to what your mortgage payments will be going forward and to adjust your budget to suit. Renters will not be immune to the changes as landlords seek to recover higher interest costs through higher rents. Ultimately, if rising interest rates and declining property prices erode investment returns for landlords, some will undoubtedly sell up, creating a worsening supply of rental properties.

Retirees on fixed incomes will also be squeezed by rising costs, even if they are living in a debt free home. Investment returns are not keeping up with inflation, and this means rising costs will be met by using up investment capital at a faster rate.

It’s time to cut back on spending.

The first step in reviewing your budget is to take a close look at your current outgoings and clearly distinguish between wants and needs. Categorise your outgoings under three headings; your financial commitments, such as rent, mortgage and insurance over which you have little control, your essential spending such as food, petrol, power and phone, over which you have some control, and your discretionary spending, such as entertainment and gifts, over which you have a high level of control.

The second task is to prepare a budget based on your new level of outgoings, factoring in higher mortgage payments or rent and higher living costs in general. To adjust your expenses, start by cutting back on discretionary items as they are the easiest to control. Next take a look at essential spending. Food is usually your biggest expense item after your rent or mortgage and because you have a reasonable degree of control over how much you spend, with a bit of discipline you can make considerable savings. Finally, take a look at your financial commitments. It is difficult to get savings in this area without making a substantial change to your lifestyle, such as moving to cheaper accommodation.

Now more than ever is the time to completely eliminate short term debt – that is, credit card and store card debt. Whatever you do, stop spending borrowed money and get rid of your debts as quickly as possible. High short term debt is the prime cause of financial stress.

If you have tightened up your expenses and still can’t make ends meet, try asking these questions:

  • Are there ways in which you can easily increase your income, for example by taking on a part time job or taking in a boarder?
  • Can you lower your contributions into KiwiSaver without missing out on any employer contributions or tax credits?
  • Can you lower your short term debt repayments by refinancing at a lower interest rate?

Finally, there are the ‘last resort’ questions:

  • Should you take a contribution holiday from KiwiSaver?
  • Can you lower your mortgage payments by making your mortgage interest only for a short period of time, by increasing the period of the mortgage, or by taking a mortgage repayment holiday? These options are best discussed with your bank.

If the answers to these questions don’t solve the problem, you are probably in need of assistance from a budget adviser or other professional expert. Take action before your debts get out of control.

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