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W & K

Borrow with Caution

When interest rates are low and property prices are rising rapidly, it can seem tempting to borrow more. Naturally, property owners feel wealthier when property values have risen. Their share of the property effectively is increasing, relative to that of the lender.

One of the dangers with feeling wealthier and more confident is that it can easily lead to taking on riskier ventures through borrowing more money. Obviously, it is very difficult to get through life without borrowing especially if you do not want to live in rental housing.

It is easy to make mistakes when borrowing. These can have a major impact on your financial wellbeing. The following are some suggested guidelines.

Only borrow what you need and only for essentials. The cost of a purchase is always greater with borrowed funds, so keep borrowing to a minimum. You may need to borrow to buy a car but it doesn’t have to be a late model car. Travel, clothes, new smart phones are all nice to have but borrowing to enjoy life now, will impact on your later years. You may not be able to fund an enjoyable retirement.

Pay your borrowings off on time and as quickly as possible. While mortgage interest rates are low, standard credit card interest rates and store card rates are around four times higher. Only borrow on cards that you can pay off within the interest free period.

Find the cheapest source of borrowed funds. If you have to borrow for essential spending, shop around for the best deal on interest rate and other borrowing costs. It’s better to borrow at mortgage interest rates of 4-5% than to pay credit card and store card interest rates.

Borrowing to invest. Some investors who are disillusioned with bank term deposit rates are turning to property investment, using their available funds or home equity as a deposit and borrowing the rest. With property values increasing at a faster rate than interest rates, this on face value can make sense. But caution is needed as interest rates may increase in the medium term and property values may eventually stagnate or even fall. Even worse could be the potential impact of a capital gains tax. This could trigger a decline in property values, or be a big impost on sale proceeds.

The golden rule with borrowing should be to proceed with caution. Make sure that you can financially or emotionally cope with the worst-case scenario. If in doubt, don’t. That will save sleepless nights worrying about being able to meet your interest payments. It may well be prudent to seek and pay for unbiased financial advice. It may save a lot of angst and money in the long run.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.