Sunday 7th October, 2007

 

Get beyond the mortgage

 
 
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The old story of estate planning is now enshrouded in a set of new rules. We are familiar with budgeting and deferred gratification, however the environment has changed in essential ways.

Markets are not as predictable as before, there is significant movement in exchange rates of non-US currency, local food price inflation is above benchmarks, high bank liquidity has fuelled more consumer debt, especially in house mortgages and credit cards are widely available.

The problem with credit card debt is the annual percentage rate, which hovers around 22 per cent. The average credit card debt balances have crept upwards by some four per cent, according to Central Bank. This means more people are unable to pay off or reduce their short-term debt.

The housing boom is spurring a spate of mortgage loans—long-term debt. Some of these loans are fixed at exceedingly low rates of two per cent. Other people have to access mortgages for more expensive properties at much higher rates. One of the hidden problems with house mortgages is the cost of maintenance.

Many people borrow to acquire a first home at their maximum limit and have serious cash flow challenges. They can find themselves in a vicious spiral. Move-in normally occurs without full furnishing, so for several months, new fixtures, curtains, water tanks and pumps, landscaping, eat up disposable income. Then living expenses go up and children become more expensive!

Homeowners’ dilemma

Many homeowners struggle to upkeep the property. They forego a new coat of paint and routine maintenance on the building. This is a trap that results from poor planning.

There is one systematic way to avoid the trap: it is to choose cash value insurance to cover the mortgage loan.

Normally the recommendation to cover the mortgage is term insurance, because it is cheapest. But in light of the changing consumer experiences, term insurance may not be the most cost effective way to cover with risk.

What exactly is the risk?

To borrow the money you must have collateral. This collateral is commonly in the form of life insurance. Without it, the lenders will seize your property should you die before you pay off the loan.

Homeowners will not like this to happen, since their families will be out in the rain, so they insure the loan.

Optimum planning strategies will incorporate into the insurance plan, a systematic savings element that will furnish a quantum of money periodically, say every ten years for property upkeep. The three common items are: the roof, repainting and the kitchen cabinets.

The old ideas of hoping to get another loan or using money saved for such maintenance are not working out since cost of living day to day is increasing too rapidly.

Another new rule in managing mortgages better is the concept of buying down the debt. This involves paying off more than the monthly instalment as soon as you can, especially now that there is no tax incentive for mortgages.

You want to get past the mortgage, so that you can pump more into your pension or annuity, where there is a bigger tax incentive.

Borrowing is a fact of the modern era, and many of us spend more, with the hope of acquiring assets.

Remember you have to maintain the asset, if you want to develop an estate that is worthy of your heirs.

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Designed by: Randall Rajkumar-Maharaj · Updated daily by: Nicholas Attai