“Don't sail out farther than you can row back.” This Danish saying is sound advice for anyone thinking of borrowing to buy a home, particularly now that interest rates are low and house prices are generally rising.
According to a paper1 for the Centre of Policy Development and University of Canberra, as Australians, we have a tendency to be over-confident in our ability to repay loans. We also tend to underestimate the potential for things to go wrong in our lives.
How to reduce stress
Like most things in life, it’s difficult to make borrowing a stress-free exercise, but there are a few things you can do to reduce the angst.
- Don’t borrow the maximum amount
Most financial institutions determine the maximum loan they will provide based on a multiple of your income and other factors. But if you borrow the maximum amount, you may find you are stretched from day one unless you are very disciplined with your budgeting.
- Build up a buffer
It’s a good idea to hold (or build up) a cash reserve in a mortgage offset account to provide a buffer that can be drawn upon to meet your loan repayments if you become ill or are off work for other reasons.
- Consider mortgage protection insurance
Many lenders offer insurance when you take out a home loan that covers the mortgage (often up to a specified amount and for a particular period of time) if you die, become disabled or your employment ends involuntarily.
- Consider personal insurances
While mortgage protection insurance can provide peace of mind for a limited time frame, other types of insurances should be also be considered. These include:
- income protection insurance which can replace up to 75 per cent of your income if you are unable to work due to illness or injury. This can ensure you are able to continue meeting the majority of your living expenses, not just your loan repayments.
- critical illness insurance which can help you service or pay off your loan and meet a range of expenses in the event you suffer a specified illness, such as cancer or a heart attack.
- total and permanent disability insurance which can help you service or pay off your loan and provide an ongoing income if you become totally and permanently disabled.
- life Insurance which can be used to service or pay off your loan and provide your family with an ongoing income if you pass away.
- Seek advice
It’s essential to seek financial advice, as there may be a range of potentially viable options to explore.
Speak to your financial adviser to discuss your insurance options.
- Source: Understanding human behaviour in financial decision making: Some insights from behavioural economics. Paper to accompany presentation to No Interest Loans Scheme Conference “Dignity in a Downturn” June 2009. Ian McAuley, Centre for Policy Development and University of Canberra.